Still Struggling to Understand How Bonds Work

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Alice Ranch
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Joined: Sat Mar 29, 2014 12:20 pm

Still Struggling to Understand How Bonds Work

Post by Alice Ranch » Wed Jan 18, 2017 12:32 pm

Recently I heard this headline on the car radio:

"Treasuries rally, yields drop."

I just don't understand why if yields drop that this would be considered a rally. Could someone explain?
:confused

jebmke
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Re: Still Struggling to Understand How Bonds Work

Post by jebmke » Wed Jan 18, 2017 12:36 pm

the price of the bond rises so anyone holding the bond has an asset that is worth more than it was before the move. Bond traders make or lose tons of money in this market.
When you discover that you are riding a dead horse, the best strategy is to dismount.

Rupert
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Re: Still Struggling to Understand How Bonds Work

Post by Rupert » Wed Jan 18, 2017 12:40 pm

Bond prices and yields tend to move in opposite directions. So if prices go up, yields will typically fall. Bond traders are more interested in prices, as they make money in the buying and selling. So rising prices is a rally as far as they are concerned. As a bond owner, though, you have to look at both figures to determine how your investment is really doing. That's my rudimentary understanding anyway. I'm no expert either.

ruud
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Location: san francisco bay area

Re: Still Struggling to Understand How Bonds Work

Post by ruud » Wed Jan 18, 2017 12:40 pm

In very simple terms:

Imagine a piece of paper that says "On date X I will pay you $100".

If you hypothetically buy this paper for $90, you'll have gained about 11% on your investment when date X comes around.

Imagine the market price for these papers rises to $95 for whatever reason, so if you now buy one, your gain will only be 5.5%.

So, the price "rallied", your "yield" dropped.
"A good plan, violently executed now, is better than a perfect plan next week."

Doug E. Dee
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Re: Still Struggling to Understand How Bonds Work

Post by Doug E. Dee » Wed Jan 18, 2017 12:41 pm

There's an inverse relationship between price and yield.

retire57
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Re: Still Struggling to Understand How Bonds Work

Post by retire57 » Wed Jan 18, 2017 3:56 pm

ruud wrote:In very simple terms:

Imagine a piece of paper that says "On date X I will pay you $100".

If you hypothetically buy this paper for $90, you'll have gained about 11% on your investment when date X comes around.

Imagine the market price for these papers rises to $95 for whatever reason, so if you now buy one, your gain will only be 5.5%.

So, the price "rallied", your "yield" dropped.
Great explanation. Thanks!

Artisan
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Re: Still Struggling to Understand How Bonds Work

Post by Artisan » Wed Jan 18, 2017 4:05 pm

The Bond Book by Annette Thau.

Caduceus
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Re: Still Struggling to Understand How Bonds Work

Post by Caduceus » Wed Jan 18, 2017 4:31 pm

Whenever you hear any discussions about bond, you have to distinguish between whether they are talking about price or yield, as those are inversely related. When the price of a bond goes up, its yield decreases, and when the price of a bond goes down, its yield decreases.

Consider a bond with a face value of $100 that gives you fixed coupon payments of $2.50 semi-annually. The current yield is 5%. If the price of the bond drops from $100 to $90, you still get the fixed coupon payments of $2.50 semi-annually. If you buy the bond in the secondary market, you can now purchase that stream of coupon payments for less than $100, so the effective yield has gone up.

When bond prices rally, bond yields drop.

dbr
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Re: Still Struggling to Understand How Bonds Work

Post by dbr » Wed Jan 18, 2017 10:27 pm

Caduceus wrote:Whenever you hear any discussions about bond, you have to distinguish between whether they are talking about price or yield, as those are inversely related. When the price of a bond goes up, its yield decreases, and when the price of a bond goes down, its yield decreases.

Consider a bond with a face value of $100 that gives you fixed coupon payments of $2.50 semi-annually. The current yield is 5%. If the price of the bond drops from $100 to $90, you still get the fixed coupon payments of $2.50 semi-annually. If you buy the bond in the secondary market, you can now purchase that stream of coupon payments for less than $100, so the effective yield has gone up.

When bond prices rally, bond yields drop.
And people speculating in the value of bonds find this good, which is why it is reported in positive light in the speculation oriented news media. On the other hand, long term investors benefit from being able to reap a good yield from their investments and would like to put money at high yield, which will eventually accrue to their benefit no matter the price.

rai
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Re: Still Struggling to Understand How Bonds Work

Post by rai » Wed Jan 18, 2017 10:33 pm

There's a simple book I've read 'why bother with bonds'

It's a short read $5.99 on Amazon https://www.amazon.com/gp/aw/d/B00PL7WS ... 8&qid=&sr=
"Life is what happens to you while you're busy making other plans" - John Lennon. | | "You say that money, isn't everything | But I'd like to see you live without it." - Silverchair

Alice Ranch
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Re: Still Struggling to Understand How Bonds Work

Post by Alice Ranch » Thu Jan 19, 2017 1:10 am

Thank you everyone for the examples and reading references. I think I've got it now.

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