In this revision video we work through some numerical examples of the inverse relationship between the market price of fixed-interest government bonds and the yields on those bonds.
Government bonds are fixed interest securities. This means that a bond pays a fixed annual interest – this is known as the coupon
The coupon (paid in £s, $s, Euros etc.) is fixed but the yield on a bond will vary
The yield is effectively the interest rate on a bond. The yield will vary inversely with the market price of a bond
1.When bond prices are rising, the yield will fall
2.When bond prices are falling, the yield will rise
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So if the bond was originally issued by the government at a nominal of £100 with a coupon of £10 it would mean that your fixed interest is 10%, so in effect you'd receive 10 pounds for every year you held onto the bond.
However, if you bought this bond from someone else for let's say £110, you're paying more money for the same return. Therefor your yield would be diminished because the coupon is fixed for the life of the bond.
Now let's say you have your bond that you paid £110 for, but elsewhere people can buy bonds with a larger coupon (let's say 20%)
There's no way in hell you're going to be able to sell on your bond for the same price you bought it as a buyer could get a much better fixed interest elsewhere for the same price. The interest on your coupon is fixed so you can't change that. The only way you're going to be able to make your bond attractive to a buyer is to sell it for less.
This is obviously a simplified version of events, but you get the picture.
The interest rate (coupon) is fixed at outset. The prevailing lending interest rate outside of the bond can vary, and this will have an impact on the Bond value. Lending rates, inflation and credit worthiness are all risk factors to Bonds and affect their price and therefore their yield
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