Finance and capital markets
Why yields go down when prices go up. Created by Sal Khan.
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- If bonds are actually bought from governments during auctions, how come i continually get to read about changing yields? What I mean is how the trading of bonds between investors affects the future price of bonds sold by the governments? How does the market price of bonds correspond to auction prices?(8 votes)
- Only few banks are able to buy the bonds directly from the government. Other players have to acquire them on the secondary markets, where people can openly buy and sell them. Then the laws of supply and demand dictate the price, and not the results at the auction.(13 votes)
- What is the meaning of face value?(4 votes)
- The face value of a bond is the amount you receive when the bond matures. This is usually the same price as the bond is issued at, but not always.(6 votes)
- In the previous videos Khan talks about how interest rates go up or down which in turn affects the price of the treasury/security. In this video, Khan talks in reverse. Could someone please explain which way this operates? Thanks.(3 votes)
- This is like asking whether the Euro or the dollar is responsible for changes in the Euro/dollar exchange rate. They are just two sides of the same coin. If interest rates rise, it makes bonds worth less. If bonds are worth less, it has to be because interest rates rose.(3 votes)
- What interest rate is the rate the generally affects all other bonds? When we talk about interest rate risk, what is the rate that determines the new Yield to Maturity of other bonds?(2 votes)
- This might sound like a silly question, but how can you buy a $1,000 face value bond for $950? (._.) Does this have to do with interest rates or something, like in the previous video.(2 votes)
- It depends on what periodic payments the bond gives you. These are called coupons.
Some bonds pay you interest every 6 months. If that rate exactly matches the market rate, then the bond will sell for face value.
At the other extreme there are zero coupon bonds, which don't make any periodic payments. You get all your return from buying it at a price well below face value and then getting repaid the face value later.
You can have coupons that are above market rates, and then the bond will sell above face value. Below market, it will sell below.(2 votes)
- I keep hearing that if a company has lot of bonds in its portfolio and if the interest rate increases it bad for the company. I get confused with this statement, because to me if I buy a bond with coupon/interest rate say 5% and maturity is 10 years. I will get the 5% return for the full 10 years, no matter what the interest rate is after 10 years. Say interest rate after 2 years increases to 7%, I will get only 5% on the other hand say after 7 years if interest rate decreases to say 3% I still get a 5. And also its always good for the investor if the interest rate is high, he will get more returns.
Also if he is trying to sell the bonds in the secondary market at a time when interest rate is 7%, he would incur a loss. Because who would buy a bond with 5% return when they can buy new bonds with 7%. In such senarios I would hold the bonds till maturity and get the interest for which I invested.
Below am reproducing the lines from a book which confused me..
"Hedging Price risk: for example portfolio manager of a pension fund may hold a substantial position in long term U.S treasury bonds. If interest rate rise value of the Treasury bond will decline. To hedge that risk, the portfolio manager can sell U.S treasury bond futures."
Yes I agree and understand that if interest rate rises the value of bond will go down. But that is only for the new bonds that he is planning to purchase and to me its good for portfolio manager because he has to pay less for the new bonds, and bad for U.S treasury who is selling the bonds..
Either my understanding of the bond principle's is terribly wrong or how I articulated the example is wrong.. Any help would be highly appreciated..(1 vote)
- why do people sell bonds when the treasury raises the rates ? aren't the bond values still the same, meaning you still get paid the coupon and your money back at the end of the term?(1 vote)
- Let's say you buy a 10 year bond that pays 5%. At the time you purchase this bond it is fairly valued (meaning it costs you $100 to buy the bond and it will mature in 10 years at $100).
If interest rates go up, the price of the above bond will fall. For example, if interest rates go up to a point where people now want 6% over 10 years, then 5% won't appeal to them. If you hold the above bond until maturity you will still receive your 5% coupon and $100 at maturity, as long as whoever issued the bond doesn't go bankrupt. But in the mean time the price of the bond will fall because why would people pay $100 for a 10 year bond that pays 5%, when they could buy a 10 year bond that pays 6% for $100?
How much the bond falls in value will depend on a number of factors.(2 votes)
- Ive seen some short term bonds with negative yield. Is people who buy them just crazy?. I dont get the idea that this bonds are safer than having it at 0% rate at your bank.(1 vote)
- There are a few different reasons.
1. Short term treasuries are considered the safest asset in the world. In times of great financial stress, people may view them as safer than cash in a bank because the bank could always become insolvent.
2. Negative yields have happened regularly in inflation protected bonds. These bonds are adjusted each period for inflation. So, if investors are expecting inflation in the future, they may be willing to sacrifice interest payments for guaranteed inflation protection.
3. A lot of money that is invested is subject to rules. The fund you invest in may have stipulations on how much money it can have sitting in cash. If that number is quite low (which it often is), in times of turmoil they may buy the closest thing to cash, which is short term treasuries, regardless of the yield.
4. If a bond is yielding -0.5% and you buy it and the yield subsequently falls to -1%, you just made money and can sell at a profit.(2 votes)
When you buy a US Treasury security, you're essentially giving a loan to the US federal government. And just as an example here, I have a US Treasury security, in which it says that the owner of this piece of paper will be paid $1,000 in one year. So if you buy this from the Treasury-- or maybe you're buying it from someone else, but let's just say that the government is issuing them right now-- let's say you buy it for $950, and the government will give you this security right over here. Now fast forward one year. You're holding this security, and what happens? So you know, all that stuff is written there. What happens a year later? Well, written on the security-- and I've simplified it just for this example-- it says the holder of the security will get $1,000. So at this point, the US government has to give you $1,000. So when you look at just the money flows, it's pretty clear that you just lent them money. You gave them $950 now, and then a year later they give you $1,000. And if you wanted to put this in terms that you normally associate with borrowing money, in terms of how much interest did you get? Well, you lent $950, and you got back $1,000. So let's think about this way. Let's get a calculator out. So 1,000 divided by 950 is equal to 1.05-- and just to round it-- 1.053. So you got 1.053-- or 105.3%-- of your money back. So let me put it this way. So this is 105.3% of money lent, of money given, of money given to the government. Or another way to think about it is, you got a 5.3% interest-- or you lent your money out at an annual interest of 5.3%. You got your money back, plus you've got 5.3% after one year. So you could imagine, if all of a sudden many people want to buy this government security, and now the price goes up. Instead of being $950, let's imagine that it is now $980. What is the implicit yield that the person would now get on it? Well, we get the calculator back out here. So you're going to get $1,000, and if you paid in $980 instead of $950, then a year later when you get the $1,000 back, that will only be 102% of your money. So in that situation it would be 102% of your money. So with the $950 price, you're essentially lending the government money at 5.3%, and at $980 you're lending the government money at 2%. And I'm doing this to show you a point. When the price of the treasury security goes up, as happened in this case, the yield-- the interest-- that you're getting on your loan goes down. Because in either situation you're going to just get $1,000 back. If you lend $980 and get $1,000 back, you're only getting 2% on your money. If you lend $950 and get $1,000 back, you get 5.3%. And so this is what people are talking about when they say if treasury prices go up then the yield goes down. So if there's more demand for treasuries the interest rate on treasuries will go down. In the next video we'll talk about how this might change for treasuries of different maturity dates.