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Summer School: Bond price and yield

Marketplace Staff Aug 22, 2007
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Summer School: Bond price and yield

Marketplace Staff Aug 22, 2007
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TESS VIGELAND: Ah yes, that may be true, but here at Marketplace Money, summer school is in session.

We’ve certainly learned a lot these last few weeks. Things like PMI, Short Sale and consumer sentiment. But you know what goes along with school, don’t you?
Here’s your first pop quiz.

CLASS: Awwwww . . .

All right, all right. Who can tell me the definition of a bond?

SOUND: Jeopardy Think Music

Alright a show of hands if your answer was a fixed-income security.
Excellent. This week, we’ll learn a little bit more about bonds — the difference between price and yield. At the blackboard this week, economist Greg McBride.

GREG MCBRIDE: The price of a bond is the price at which a bond is currently trading and the yield reflects the return the investors will earn if they buy that bond and hold it until it matures. Now what happens is that prices fluctuate on an almost daily basis in markets. And as the prices fluctuate, so too do the yields.

People often wonder why if a bond price rises does the bond yield fall. With a bond, you know what you’re going to get when the bond matures. And when you pay a higher price, the yield that you’re going to earn between now and when it matures is actually lower than if you had purchased the bond prior to that increase in price. As bond yields rise, those yields become more attractive relative to the returns that investors could get some place else, such as in stocks. In the opposite vein, if bond yields are falling, that makes stocks more attractive. When yields are rising and prices are falling, that makes buying much more attractive, but it’s not necessarily a good time to be selling those bonds. Because after all, you’re getting a lower price today that you would have the day before.

Now look at the rising yield. That has different implications for consumers. For example, when the yield on a 10-year Treasury note rises, fixed mortgage rates often rise right along with it. So rising bond yields actually make those mortgage that home buyers are out there getting more expensive. The inverse is true as well — if bond yields fall, so too do mortgage rates.

VIGELAND: Our teacher this week was Greg McBride, he’s a senior analyst for Bankrate.com. Next week, rebalancing your portfolio: What does that mean?

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