The Yield Curve – 5
Back to the Yield Curve. Whenever a company or the Government issues bonds, it is for a fixed duration. Say, 5 years. Say I bought the bond and after 2 years want my money back? If the company has to take back the bond, then the very purpose of issuing the bonds – getting money so that they can invest for the long term – is lost. So, they don’t take it back but list it on the stock exchanges. Like shares, bonds also can be bought and sold. The price of the bond, like shares, also goes up and down. The %age return on your investment that you will get when you buy a bond from the market is called a ‘Yield’. It is different from the initial rate (or the Coupon rate). Now why the Yield is different from the Coupon is a bit complex and you can read my article to understand why by clicking:
Do read and understand it and you will realise that whenever the bond prices go down, the bond yield goes up! This is very important and took me a long time to understand. If in doubt, do send me a message.
PS – We have some good offices for sale, rent or prelease sale near Turbhe Station, Navi Mumbai at distress prices. Ready and under construction. Do let me know if you are interested.
The Yield Curve – 6
Assuming by now that you understand that the ‘Yield’ and the ‘Price’ of the bond is in an inverse relationship. If you haven’t bothered to read the article, take my word for it. Whenever the price of a bond goes down, the returns from the bond go up.
Now, why would the price of a bond go down? Why does the price of anything go down? Lots of people are selling it and the demand is lower. Isn’t it? So, if people are selling a particular bond, then something is not right with it – maybe the company issuing it is not in such a financially sound condition or maybe bonds with a higher rate of interest from a more stable company are available.
Understand this clearly – if there is a sort of ‘risk’ with a particular bond, people will sell it and the price will fall and when the price falls, the yield or the return on your investment will go up! So, riskier the investment, the higher the return.
So, when someone says “Put your FD is XYZ bank, the interest rate is nearly 2% above that of SBI” or “Invest in ABC company debentures, the interest rate is nearly 3% above that of an FD”, you should understand that the higher interest rate is because of the higher risk involved. It is still okay to invest there but you should know and understand the risk. Maybe you should put a lower amount there.
The Yield Curve – 7
Happy Ganesh Chaturthi to all!
It is our 11th birthday today. We started in 2008 on Ganesh Chaturthi day. Humbly thank all of you for your support through some very trying times.
By now, it should be clear that any company or government offering a higher rate of return on investment means that there is a higher risk involved. Somehow, for most, the ‘risk’ part of the equation does not trigger at all.
Recently a group of investors took Karvy Wealth Managers to court complaining that they had been cheated. It seems the company had offered them 20% guaranteed returns!
For a long time now, if anyone offered me absolutely safe 20% returns, the next thing I would do is ———-
Hold on to my wallet and RUN!
PS: Always know that OTPs are only generated when you try to do a transaction for taking out money from your account. So, when someone calls you and tells you that he or she is from a service provider and to please give him the OTP, cut the call!!
Yield curve – 8
This is to explain why the yield goes up when the price of the bond goes down.
Say, you bought a 5-year bond issued by company XYZ, each of face value Rs.100 of tenure of 5 years and a coupon rate of 10%. This means that the owner of the bond is assured of Rs.10 every year (of course, assuming that the company is not bankrupt).
After two years, you read something worrying about the company and decide to sell the bond in the open market. Since there will be quite a few guys selling it, will the price of the bond go up or down? Anything being sold on a large scale ensures that the price will drop. Say, I bought the bond from the market for Rs.80.
I will still get Rs.10 every year from the company. So my Yield becomes 10 * 100 /80 = 12.5%! Conversely, when the price of the bond rises, the Yield falls. Now, this is something that is not intuitive – if the yield falls, the bond is sought after, which means the issuer is sound. If the yield rises, the bonds are being sold, which means the issuer has a problem!