Bond Yield – Basic Ideas

Unlike the share market when the bond yield goes up the bond price actually goes down. This is in fact in a bit different than what we normally observe. Below is the detail explanation of exactly what happens.

Understanding the concept is fairly simple. It is a piece of document which promises you to payback your invested principle after the maturity date plus an interest (simple or compound) in fixed intervals. These are not same as stock market shares. When you own a piece of company share then you own the company with its risks for as long as you own the stock. Bonds in the other hand have a maturity date and you will get the promised interest on the money and will get your principle back after maturity.

There are various types issued by various entities. The include but not limited to – Federal Government, Provincial Government, Local Governments, Corporations etc. Bonds are generally considered very sound investment if issued by a financally sound government. There are cases where a government has failed on its bonds.

Bond has few important terms, such as price, Interest rate, Par value, maturity date and finally bond yield. Generally in the mortgage market the most discussed terms are Price and Yields.

Assume you own a bond of 100 $ value with a 2 years maturity. The interest rate is 6% per year. So, you will receive a total of 12 $ (based on simple interest) within this 2 years. Now you want to sell your bond in the middle of the term. You get an offer of $ 90 for that bond. The new owner will receive 106 $ after one year on an investment of $ 90. He / she will earn (106-90) / 90 = 17.78% on that bond. That is called bond yield. Here when bond prices go down yields returns up.

Following are some examples of many types of bonds available in the market.

– Convertible bonds
– Corporate bonds
– Eurobonds
– Extendible / retractable bonds
– Foreign currency bonds
– Government bonds
– High yield bonds
– Inflation-attached bonds
– US Treasury inflation protected securities (tips)
– Mortgage-backed securities
– Zero coupon or "strip" bonds
– Asset-backed securities

Many analysts in the market tend to use the yield curves to predict the future. It is not a very well proven idea. Many times those predictions have missed their targets. It can give you a fair idea about what is coming but not without its drawbacks.

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