Yield on India’s benchmark 10-year bonds will stay soft in July, according to Bank of Baroda (BoB) Research.
What is a Bond?
A bond is a loan made by an investor to a borrower for a set period of time in return for regular interest payments.
The time from when the bond is issued to when the borrower has agreed to pay the loan back is called its ‘term to maturity’.
The bond issuer uses the money raised from bonds to undertake various activities such as funding expansion projects, refinancing existing debt, undertaking welfare activities, etc.
What is Bond Yield?
It is the return an investor expects to receive each year over its term to maturity.
It partially depends on coupon payments, which refer to the periodic interest income obtained as a reward for holding bonds.
The bondholders receive the bond’s face value at the end of the bond’s life. However, one may buy bonds at par value, discount (at a price lower than par value), or premium (at a price higher than par value) as they trade in the secondary market.
Therefore, the prevailing market price of bonds also affects the bond yield.
It is calculated by using the following formula:
Bond Yield = Coupon Amount/Price
Bond Yield vs. Price:
The prices at which investors buy and sell bonds in the secondary market move in the opposite direction to the yields they expect to receive .
Once a bond is issued, it offers fixed interest payments to its owner over its term to maturity, which does not change.
However, interest rates in financial markets change all the time, and, as a result, new bonds that are issued will offer different interest payments to investors than existing bonds.
For example, suppose interest rates fall. New bonds that are issued will now offer lower interest payments.
This makes existing bonds that were issued before the fall in interest rates more valuable to investors, because they offer higher interest payments compared to new bonds.
As a result, the price of existing bonds will increase.
Bond yield is the earning of an investor from a bond over a specific tenure, expressed in a percentage. It is dependent on the interest rate and bond price.
As a result, when the interest rate falls, and the bond price is higher than the face value of the bond, your bond yield will be lower than the coupon rate.
Similarly, when interest rates rise and bond prices are lower than the face value, your bond yield will be higher than the coupon rate.
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