Bond Yield and Price - Prabhudas Lilladher

PL Knowledge Centre-

Bond Yield and Price

Bonds are a form of debt securities issued by the government or company. Both

the governments and the companies issue bonds to meet their borrowing

requirements.

The common terminologies used while investing in bonds are coupon, yield and

price.

Coupon is the interest rate that a bond holder will receive regularly. It is

expressed as a percentage of the face value. Suppose a bond pays a coupon of 5

percent and the face value of the bond is Rs.1000, then the bond holder will

receive a regular interest payment of Rs.50.

Yield is the return on your investment from a bond. For instance, if a bond is

bought at a face value of Rs.1000/- and the annual coupon is 6 per cent, then the

yield in this case is the coupon itself since it is bought at its face value. Since

bonds are traded in the secondary debt market the bond price changes

dynamically, hence the yield is also dynamic.

In this issue of Knowledge Centre, we will help you understand the relationship

between the bond price and yield.

When rates of interest in the market go up, bond prices fall and bond yields will

go up. This is because the buyer of the bond will pay less than the face value but

will receive higher returns since the coupon payments are the same.

Scenario I: Interest rate goes up

Suppose new issues of bonds of comparable maturities become available in the

market at a higher rate of interest, i.e.at 8 per cent, and then the price of the

existing bonds will come down so as to get a return similar to the newly issued

bond. In this case the prevailing market price for a bond with face value of rs 1000

will be: Annual Interest Payment/Current Yield

Prevailing Market

Price=60/0.08=Rs.750

Scenario II: Interest rate goes down

On the other hand, if new bonds are sold in the market at an interest rate lower

than the coupon rate available on similar bonds, i.e, in this case at 5 per cent,

then the price of the existing bond will increase so as to get a rate of return

equivalent to 6 per cent.

Prevailing Market

Price=60/0.05=Rs.1200

In short, a bondholder will prefer to buy a bond when the price is quoting lesser

than the face value, since it will give him a higher yield of 8 per cent, considering

the inverse relationship between yield and bond price

Karan Chimandas Kripalani

+91 22 66322298 | karanchimandas@

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