Businessman Investor

Touching base with the rational business psyche of stock market investors

Friday, August 12, 2011

Bonds and Yields Simplified

To those familiar with bonds, how often do we hear that when interest rates go up, bond prices go down? Why does the price of bond move opposite its yield? The relationship is naturally inverse but why?!

Perhaps it's not so easy to digest because the idea of interest rates being the one responsible (or the one causing the movement) of bond prices doesn't have so much concrete/obvious logic into it. So how about putting it this way instead: Bond price dictates yield. Just like the relationship of stock price and its dividend yield, intuitively, we know that when a stock price shoots, the prospect of dividend yield drops.

Going back to bonds, let's try a very simple, straightforward example to put things into perspective:

Let's say I'm a very popular listed company about to issue some debt instruments; I needed more capital since I'm aggressively growing my business. I issued Php 100 worth of debt (principal) maturing in 10 years at the coupon rate of 10%. Knowing that I have good credit standing making my debt or bond issues marketable in the secondary market (e.g. PDEX), you availed of all bond issues at the cost of Php 100 (it isn't at a premium or discount since your acquisition cost is the same as the original principal issue). Effectively, your yield is equal to the coupon rate of 10% and you're assured of a Php 10 interest annually.

Now, a friend came along and knew about the bond you're holding. He's very interested in buying it since he knows the issuer is of good credit standing. You two bargained for a trade price to where you both agreed at Php 110—he will be buying your Php 100 worth of bonds at Php 110 (at a premium). What will happen to his yield? Obviously, it will be lower. From the original 10% yield, his yield will just be 9.09%. (Php 10/110). That's why yields go up and down. For me, the yield is dictated by the price, not the other way around—although most bond market traders (being so conscious of interest rate movements) have been psyched to think otherwise.


  1. I'm interested into bond trading but I'm just unsure where to start. I believe PDEX is our local bond exchange (?), who are the brokers? Btw, I'm just a small-time retail investor.

  2. Hi ScIoN, thanks for dropping by. I've invested in bonds at least once, and that was when they offered the San Miguel Brewery Corporate Bonds back then. Basing on experience, retail investors can tap into bonds through the treasury groups of banks or investment houses (check out division, on behalf of the bank or investment houses it represents, is the one responsible for trading through the PDEX; try contacting your local bank and inquire about it. Usually, as in all placements, they'd require a minimum transaction amount depending on the bond you're prospecting to purchase. Hope this helps. Good luck!



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