Bond Price relation with Bond Yields

Bonds market yesterday rallied as RBI promises to provide liquidity of Rs.36,000 Cr in the Bond Market through OMO( Open Market Offer).

The 10 Year bond yield yesterday closed at 7.99% as compared to 8.03% on Friday because of this RBI inflows news. The Crisis in the Bond Market is elevated as FII are continuously pulling out the money from the Bond and Equity market since April 2018.

Bond Yield relation with Bond Price?

As a rule of thumb, as Bond Yield Increases the Bond Value decreases.

How does this concept work?

Suppose investor “A” buys a bond with FV=1000, having the coupon rate of 10% for 3 years. So every year he will receive Rs.100 as a fixed interest and the bond with FV=1000 will trade in the market. The F.V will keep on changing as per demand and supply in the bond market. However, the investor is entitled to a fixed interest of Rs.100 irrespective of bond price fluctuations.

Now after the one-year same company comes up in the bond market and offering 12% Coupon rate for the FV of 1000( This happens when Interest Rates are rising). The Investor “B” grabs up the opportunity and buys the bond.

What does investor ” A” will do now??

He will observe that the Investor “B” having the same FV as mine is earning more interest per year, then why should I carry my bond which is giving me less interest. So he will start selling the bond.

Similarly, the other Investor like “A” will also start selling the bond in the market to buy another bond similar to investor “B” and thus Bond Price Falls.

The Vice-Versa happens if the company comes up with the lower interest rate on bond with similar face value.

The Current Situation in the Indian Economy is similar to the first case. The Interest Rates in the Indian Economy is rising, so it is affecting the bond market prices. Imagine a situation if everybody starts selling then who will buy the bonds to give support to falling price. Therefore, RBI intervenes with OMO whereby they will buy bonds in the market to support it.

Hope this Article must of clear many doubts of the beginners.