Bond Yields Flashcards
What is bond yield?
Bond yield is the return an investor earns on a bond relative to its price. It represents the percentage income generated from the bond’s interest payments and any capital gains/losses if the bond is sold.
Describe the key relationship between bond yield and bond price.
Bond yield and bond price have an inverse relationship. If a bond’s price increases, its yield decreases. If a bond’s price decreases, its yield increases.
How does a booming economy affect bond yields?
A booming economy can lead to higher bond yields because: Investors might prefer stocks for potentially higher returns, decreasing bond demand. This leads to lower bond prices and consequently, higher yields.
How does a recession impact bond yields?
During a recession, bond yields typically decrease because: Investors seek the safety of bonds, increasing bond demand. This leads to higher bond prices and consequently, lower yields.
Explain how inflation influences bond yields.
Inflation erodes the value of future bond payments. To compensate for this risk, investors demand higher yields, driving yields upward during inflationary periods.
Why does political instability affect bond yields?
Political instability increases the perceived risk associated with a country’s bonds. Investors demand higher yields to offset the greater risk, leading to higher yields in politically unstable environments.
How do central bank actions impact bond yields?
Central banks influence bond yields through monetary policy: Lowering interest rates makes bonds more attractive, increasing demand and lowering yields. Raising interest rates makes bonds less attractive, decreasing demand and increasing yields.
What are the different types of bond yields investors track?
Three important types of bond yields: Coupon Yield: The fixed interest rate set when the bond is issued. Current Yield: Annual interest payment divided by the bond’s current market price. Yield to Maturity (YTM): The most comprehensive. Considers price, coupon payments, time to maturity, and the potential for reinvesting interest.
How does credit risk relate to bond yields?
Bonds with lower credit ratings (higher default risk) generally offer higher yields to compensate investors for the increased risk. Credit rating agencies like Moody’s and S&P assess the creditworthiness of bond issuers.
Explain the concept of interest rate risk for bondholders.
Bond prices and prevailing interest rates have an inverse relationship: Rising interest rates lead to falling bond prices. Falling interest rates lead to rising bond prices. Bonds with longer maturities are more sensitive to interest rate changes (this is related to the concept of duration).
What is liquidity risk in the context of bonds?
Liquidity risk refers to the potential difficulty in selling a bond quickly at a fair price. Less frequently traded bonds might have a wider spread between their bid and ask prices. Investors may demand higher yields on these bonds as compensation for this risk.
