Why are Bond prices and yields paid inverse?

[tommog]

maybe I have overlooked something simple but I was hoping someone could tell me a bit about the structure of price/yield movements in the money markets.

I would have thought that one would want to have a bond that paid a good yield and therefore demand would be high therefore prices high, but when yields go down prices go up not sure I fully understand why.

The way I understand it is the government issues government debt a Bond or an I.O.U, each bond requires you to pay the government $/£1000 (for example just to keep figures round) and for that $1000 investment you get, for e.g, an 5% return for the length of your Bond agreement 2 year 10 year etc. Thats about as much as I understand. I would appreciate a quick intro into the price movement please

Many thanks

 

[Ras1974]

maybe I have overlooked something simple but I was hoping someone could tell me a bit about the structure of price/yield movements in the money markets.

I would have thought that one would want to have a bond that paid a good yield and therefore demand would be high therefore prices high, but when yields go down prices go up not sure I fully understand why.

The way I understand it is the government issues government debt a Bond or an I.O.U, each bond requires you to pay the government $/£1000 (for example just to keep figures round) and for that $1000 investment you get, for e.g, an 5% return for the length of your Bond agreement 2 year 10 year etc. Thats about as much as I understand. I would appreciate a quick intro into the price movement please

Many thanks

Hi Tommog,

Basically the price of a bond and the yield of a bond have an inverse relationship, i.e. the higher the price the lower the yield and visa versa, sometimes they price drives demand and sometimes the yield drives demand. In very simple terms: If a UK Government bond is priced in the market as offering 10% yield pa and the BoE is offering 5% everyone would want to buy the bond, but as demand rises so does prices and thus the yield will fall until there is no excess demand.

Let’s say there is a bond which matures in one year at par 100 and pays 10% interest. Simply put you can buy 110 in 12 months time for 100 today – a 10% return. If you buy this bond from a friend for 101 your yield or return on the investment would only be 9% not 10%. However, if your friend sold the bond to you for 99 your yield would be 11%. This is as simple an explanation as they come but prices (and yields) vary depending on prevailing interest rates, issuer risk etc.

Take a look at the following link:
http://www.investopedia.com/university/bonds/bonds3.asp

The net is always a good source of information like this.

I hope this answers your question and let me know if you are still confused.

Out of interest what do you normally trade?

Best of luck,

Ras

 

[Rhody Trader]

Basically, what it comes down to is that the pay-out for a bond is fixed, but its prices can vary. As Ras has demonstrated when the price of the bond rises, that fixed pay-out yields less, and when it falls the pay-out yields more.

To your point about demand, a bond with a high pay-out (coupon) relative to other similar instruments (time to maturity, credit quality, ect.) with generate buying. That buying will eventually raise the price of the bond to the point where it's yield basically matches those other comparable instruments. Obviously, the opposite is true for a low pay-out bond.

 

[tommog]

Hi Ras,

Thanks for the reply it has cleared things up a lot.
In answer to your question I have been trading forex for some time so have always needed to keep an eye on the bond market/interest rates etc but have never spoken to anyone that trades bonds before and am interested in learning more about the bond markets movements from a traders perspective.

thanks Rhody also