Bond Yields are Inverse to Bonds

It’s true. Bond yields are inverse to whatever activity is happening in the bond market. What is up is actually down, and what is down is actually up… confused?

Bonds are issued at face value with a coupon rate. For example: if I buy a bond for $100 (face value), it might have a coupon rate of 5% ($5). This would mean that the bond I purchased will return $5 (5%) if I hold the bond until maturity. This is called the coupon rate. The math is simple: $5/$100 = 5%.

But what if I decide I don’t want to hold that bond until maturity? There’s only one option… I can sell it. In fact, a lot of bond traders do just that – they buy and sell bonds and make money on the difference between what they bought it for and what they sold it for. And this is where the inverse relationship between yield and bonds come into play.

Let’s say I think the market is going to go up and I want to buy stocks. I decide to sell my bond so I can have more money to purchase stocks with. I bought the bond for $100, and it had a coupon rate of $5, for a total maturity value of $105. The yield on my bond is 5%.

Because other bond holders are thinking the same thing I am – that the market is going up and they want to buy stocks – there are a lot of sellers today. When there are a lot of sellers, the price of the bond goes down, but the yield goes up…

I can sell my $100 bond with a 5% ($5) rate for $99. I lost money *cue the tears*. The person who bought my bond, bought it cheaper than I bought it for, and their yield is much better. Here is the math…

Bought: $100 with $5 rate for a total maturity value of $105 = 5% yield ($5/$100=5%)

Sold: $99 with the same maturity value of $105 = 6% yield ($6/$99=6%)

Notice, the maturity value for the new holder is the same as it was for me when I held the bond ($105). But the new holder bought the bond for $1 less than I did. So that person got a discount, and therefore received a higher yield.

There is much more to bond trading than understanding how the yields work. So don’t run out there thinking you’re a bond wizard. Always do your own research before doing anything like that.

But, hopefully now you get the idea. Whenever yields are falling, that means there’s lots of people buying bonds. Whenever yields are rising, that means people are selling bonds.

I am no bond expert, but I do understand the basic concepts. I believe it is important to know because it might give a clue as to which direction the overall market is heading.

In general… VERY VERY general… When there are lots of bond buyers, and yields are falling, that means people are getting scared. They want to invest in the safety of bonds. U.S. treasuries/bonds are considered to be super safe. Less risk, however, equals less reward. Hence why yields are very low right now.