US 10-year Bond Yields
Mg Guys Could you explain US 10 yr Bond yields , in a very simple lay mans term OR if possible in Dollars and cents I read about this , But I seem not to understand it fully PS Keep the good work coming Cheers Paul M
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Answer
Hi Paul,
Sure, we’ll do our best!
When you buy a bond, you are effectively lending the bond issuer money from date of purchase to maturity – in this case, the US Government for 10 years. Let’s assume, you pay $100 to buy the bond and the yield is 4.30% per annum. You receive $4.30 each year until the bond matures, at which time, you get your $100 back. That does not change unless the US Government defaults – which is highly unlikely. As an aside, you will be paid more for risker bonds because the chance of a default is higher. This known as a credit spread, which effectively prices the difference between safe government bonds and risker bonds.
The 4.30% yield that is offered is based on current economic conditions, that can change. These changes will not impact your return if held to maturity, however, it can create some fluctuations during the holding period. If rates are cut, or the market expects they will be, new bonds can be issued paying a lower interest rate, making your 4.30% more valuable. If for example, interest rates are cut 0.5%, the government can now issue debt (bonds) paying 3.8%. Markets are broadly efficient, so the price of your bond will increase to reflect that change and vice versa if rates go up, you’re 4.30% could look relatively less attractive, and the price of your bond will decline.
The cost of capital is very important when pricing an asset. The higher the cost of capital, the lower the implied value and vice versa. If interest rates rise, asset values generally fall. There are some offsets here in so far as rates rise because economic growth could be stronger for instance, and assets could produce higher returns, however, for the purposes of this explanation, let’s keep it simple.
We write a lot about bond yields, simply because they impact asset prices. When thinking about portfolio construction, investors hold bonds to mitigate risk, and ensure more predictability of income. Generally, if stocks are declining, it’s because economic conditions are deteriorating, which would lead to interest rate cuts. In that case, the value of your bond holdings would increase, offsetting some of the decline elsewhere.
We hope that helps.
