1/ Bonds & Yields 101

If you follow the financial news, you see and hear a lot of talk about bonds and bond yields.

But what are they and how do they work?

Here’s Bonds & Yields 101!

2/ Bonds are a debt funding instrument.

The simplest way to think about a bond is that it is a loan given to a company or government by an investor.

The entity borrowing money is said to “issue” a bond (i.e. put it up for sale). Investors “buy” the bond, providing a loan.

3/ As with any loan, the investor who purchased the bond is paid interest on the money they loaned and will receive its principal back on a set future date (“maturity date”).

The company or government that raised money can now use the funds to support operations or investment.

4/ The perceived “default risk” of the borrower (i.e. the risk of the loan not being repaid) determines the interest rate investors will require as compensation for taking this risk.

This rate is called the “coupon” of the bond.

High Risk = High Coupon
Low Risk = Low Coupon

5/ The bond “yield” is just the expected return of owning the bond.

Yield = Coupon Amount / Price

Simple Example: If I pay $1000 for a bond with a $100 annual coupon, that would be a 10% yield ($100 / $1000).

6/ Bonds are tradeable instruments whose prices fluctuate in the open market due to various factors (issuer risk profile, interest rates).

As such, bond yields are dynamic.

If I sell that same bond from above for $500, the yield to the new investor would be 20% ($100 / $500).

7/ Bond prices move based on supply and demand. More demand increases the price of the bond, and thus drives down yield (and vice versa).

Yields = Demand
Yields = Demand

8/ Why should you care? Well, we can learn a lot from the bond market.

Treasury bond yields at historic lows? Investors are buying and flocking to safety...

Hertz bond yields spiking? It may be in financial trouble...

That’s Bonds & Yields 101. Stay tuned for more!