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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