Bond yields

Definition

Bond yields refer to the return an investor can expect to earn from a bond, expressed as an annual percentage. This yield is a crucial measure for investors, indicating how much they can earn from their investment relative to its price, and it can fluctuate based on interest rates, economic conditions, and the issuer's credit quality.

5 Must Know Facts For Your Next Test

1. Bond yields are inversely related to bond prices; when bond prices go up, yields go down and vice versa.
2. In a quantitative easing scenario, central banks buy bonds to increase money supply, often leading to lower yields as demand for bonds rises.
3. Yields can vary based on the bond's maturity; longer-term bonds typically have higher yields to compensate for increased risk over time.
4. Bond yields reflect investors' expectations about future interest rates and inflation; higher expected inflation usually leads to higher yields.
5. A rising yield can indicate improving economic conditions or increasing inflation expectations, while falling yields often suggest economic slowdown or deflation fears.

Review Questions

• How do changes in central bank policies, like quantitative easing, impact bond yields?
  • When central banks engage in quantitative easing, they purchase large amounts of bonds to inject liquidity into the economy. This increased demand for bonds generally drives up their prices and consequently lowers their yields. As a result, the bond market sees lower returns for investors, which can influence overall economic activity by making borrowing cheaper.
• Analyze how bond yields can signal economic expectations among investors.
  • Bond yields serve as indicators of investor sentiment regarding future economic conditions. If yields rise, it often suggests that investors expect stronger economic growth and potentially higher inflation, leading them to seek higher returns on their investments. Conversely, falling yields may indicate investor concerns about economic stagnation or deflation, signaling caution and reduced expectations for growth.
• Evaluate the relationship between bond yield changes and investor behavior in the context of market fluctuations.
  • Investor behavior is closely tied to changes in bond yields, particularly during market fluctuations. When yields rise significantly, investors may shift their portfolios towards bonds for higher returns, reducing exposure to riskier assets like stocks. Conversely, declining yields may prompt investors to seek better returns elsewhere, often leading to increased investment in equities or alternative assets. This dynamic illustrates how bond yields not only reflect current market conditions but also influence broader investment strategies.

Related terms

Interest Rate: The amount charged by lenders to borrowers for the use of assets, typically expressed as a percentage of the principal.

Credit Risk: The risk that a borrower may default on any type of debt by failing to make required payments.

Market Price: The current price at which a bond is trading in the market, which can affect the yield based on changes in demand and supply.