What Is The Relationship Between Bond Prices And Bond Yields?
Bond prices and yields move in opposite directions. To illustrate this concept, let us assume that you are holding a bond of 1-year maturity that you bought at S$900. At maturity, you will receive your principle of S$1000. Assume the bond does not pay any coupon, so your yield-to-maturity is 11.1% at the moment:
[S$(1000-900) / S$900] x 100 = 11.1%.
If the bond price falls to S$850, the yield-to-maturity on this bond will be higher:
[S$(1000-850) / S$850] x 100 = 17.6%
Likewise, when the bond price rises to S$950, the bond's yield-to-maturity will fall:
[S$(1000-950) / S$950] x 100 = 5.3%
Intuitively, if you bought your bond when interest rates were at 4%, and if interest rates rose to 6%, it would mean that you would be able to sell your bond at a lower price than what you paid for it. This is because investors can buy new bonds that will give them a higher yield (i.e. 6%). The price of your bond will therefore decline. On the other hand, if interest rates fall, investors will find your bond attractive relative to new bonds with lower yields. Therefore, the price of your bond will rise.
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