Bond Yield

According to Bank of Baroda Research, the yield on India’s benchmark 10-year government bonds is expected to stay soft (low) in July. This indicates stable or easing borrowing costs for the government in the near term.

What Are Bonds?

• Bonds are debt instruments, like an IOU (I owe you), issued by governments or companies to borrow money.

  The issuer promises to pay back the borrowed amount (called the face value) at a future date (maturity) and usually pays interest (coupon payments) periodically.

  A bond is essentially a loan from an investor to a borrower (like a government or company) for a fixed period.

• The term to maturity is the time from issuance to when the borrower repays the loan.

  Borrowers use bond money for projects, refinancing, or other activities.

  Bondholders get regular interest payments (called coupons) and the face value back at maturity.

• Government bonds (called G-Secs in India, Treasuries in the US, Gilts in the UK) are considered very safe because they have the government's backing.

Types of Government Securities (G-Secs)

1. Treasury Bills (T-bills):

   • Short-term, zero-coupon bonds (no interest paid).

   • Issued at a discount and redeemed at face value at maturity.

2. Cash Management Bills (CMBs):

   • Short-term like T-bills but less than 91 days maturity.

   • Used to manage temporary government cash flow mismatches.

3. Dated G-Secs:

   • Longer-term securities with fixed or floating interest paid semi-annually.

   • Tenure usually ranges from 5 to 40 years.

4. State Development Loans (SDLs):

   • Issued by state governments, similar to dated securities, through auctions.

What is Bond Yield?

• Bond yield is the return an investor expects each year until maturity. It depends on the coupon payments and the price you pay for the bond in the market.

  Yield is the effective return an investor earns from a bond.

• Bonds have a face value (e.g., Rs 100), a coupon rate (fixed annual interest %), and a price (which can fluctuate). For example, a 10-year bond with a face value of Rs 100 and a 5% coupon pays Rs 5 every year. If you buy the bond at Rs 100, your yield is 5%. If the price changes, yield changes inversely (price up → yield down, price down → yield up).

• Since bonds trade in the secondary market, they can be bought at:

  • Par value (face value),

  • Discount (less than face value), or

  • Premium (more than face value).

  The formula for yield is:

• Bond Yield=Coupon Amount/ Price Paid

Yield Curve

• A graph showing bond yields across different maturities.

  Helps investors see what return to expect for lending money short-term vs long-term.

  An inverted yield curve (short-term rates higher than long-term) can signal economic trouble ahead.

Factors Influencing the Yield Curve

• Market Demand & Prices: More demand pushes bond prices up and yields down.

  Interest Rates in Economy: Bond yields adjust to match prevailing interest rates; if economy rates rise, bond prices fall to increase yields, and vice versa.

  The bond yield vs economy interest rate relationship works like a seesaw balancing between the two.

How RBI Manages Bond Yields

• RBI uses Open Market Operations (OMOs)—buying and selling government securities—to control liquidity and influence bond yields.

  Selling G-Secs absorbs liquidity → bond yields rise → borrowing becomes costlier.

  Buying G-Secs injects liquidity → bond prices rise → yields fall → borrowing encouraged.

  RBI also uses tools like repo rate, cash reserve ratio, and statutory liquidity ratio to manage the economy.

Bond Price vs. Yield Relationship

• Bond prices and yields move in opposite directions:

  • When market interest rates fall, existing bonds with higher coupons become more valuable → bond prices go up → yield goes down.

  • When interest rates rise, existing bonds become less attractive → bond prices go down → yield goes up.

Impact of Hardening Bond Yields (Rising Yields)

• Losses for Banks & Mutual Funds: Holders of existing bonds lose money as bond prices fall.

  Higher Borrowing Costs: Government and corporates have to pay higher interest on new borrowings.

  Corporate Bonds: Companies might increase interest rates to attract investors, raising borrowing costs.

  Equity Markets: Bonds become more attractive relative to stocks, potentially causing stock prices to fall as investors shift funds.

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