Question

What is the importance of benchmark bonds yield for investors and fund managers?

How does the benchmark of bonds yield is set the debt instruments market?

Answer 1

A benchmark plays a key role in the investment cycle. Often a market index, a benchmark usually offers a starting point for a portfolio manager to create a portfolio and guides how the portfolio should be managed on a continuous basis from both the risk and return perspectives. This also lets investors gage their portfolios ' relative performance. A benchmark bond is a bond that offers a norm to which one can calculate the performance of other bonds. Government bonds almost all serve as benchmark bonds.

The benchmark bond is basically a security to which the prices of other bonds react. Bond investors and fund managers use the benchmark bond as a yardstick for calculating bond performance and knowing what exceeds the benchmark yield rate of return on demand. The index and the bond being calculated against it should have equivalent liquidity, issue size and coupon to make a comparison acceptable and useful. For instance, the 10-year US Treasury bond is mostly used as a market benchmark for 10-year bonds.

Since Treasury securities are deemed to be riskless assets that are backed by the US government's full faith and credit, these securities offer a risk-free return. An investor who wants to calculate the return on a 10-year corporate bond, which is more likely riskier than a government bond, will equate the yield to the 10-year Treasury bond. When the yield on a 10-year T-bond is going for 2.85 percent, the borrower will ask the corporate bond issuers for a risk premium above 2.85 per cent.