Question

This question relates to the trading of corporate and government bonds in secondary markets. (a) Describe the main factors affecting yields on bonds?

Answer 1

There are various factors which affects the yields on bond but before that we must know what is bond yield.

So Bond yield is the actual return that an investor get till the time he holds the bond.

Factor affecting the Yields on bond -

1. Inflation situation of the country - In the situation of inflation the bond gets affected as the the value that an investor will get in future will have less value as compared to today. for example if you have a bond which pays 600 Rs every 6 month therefore in the situation when inflation rises purchasing power with that money will also decrease as a result demand of that bond in secondary market will reduce and yield will increase bond price and bond yield share inverse relation.

2. Saving tendency among public - If future of economy is not certain and markets are not performing well then tendency of saving among public increases and fixed income securities such as bond is good way to save and have a regular income therefore the demand for the bond will increase and hence price will increse which in turn reduce the yield. (bond price and bond yield share inverse relation)

3. Situation of economic growth - if there is strong economic growth in the country people will like to invest in the shares and other modes of investment because they will pay high return by taking high risk, so in that situation bond will be less attractive and therefore yield will be on higher side as bond price and bond yield share inverse relation.

4. Interset rate prevailing in the country - Interest rates also affects the bond yield lets understand it with an example

Suppose you have a bond of Rs100 which pays 6% interest . so every year you will recieve 6 rs as an interest. Now suppose the interest rates in the market increases to 8% , in that case you would like to sell that bond in the secondary market but the potential buyers in the market will compare your bond  with interest rate in the market which would be more than what your bond pays.

So your bond will be less attractive and demand of which will be on lower side as a result yield will be high.