27 Oct 2023 Bond Yield
This article covers “Daily Current Affairs” and the topic details “ Bond Yield”. This topic has relevance in the Economy section of the UPSC CSE exam.
For Prelims:
About Bond Yield?
Factors Affecting Bond Demand and Market Price?
For Mains:
GS 2: Economy
Impact of Bond Yield Hardening:?
Why in the news?
The yield on 10-year U.S. government bonds, which serves as a global benchmark for asset prices, has climbed to 5.02 percent. This marks its highest level since July 2007.
About Bond Yield:
- Bonds are financial instruments issued by governments and corporations to raise funds. The initial value at which a bond is issued is its face value, while its value in the secondary market is referred to as the market value.
- Bond Yield: Bond yield represents the return that an investor receives on their investment in a specific bond. The yield is influenced by the bond’s current market value.
- When the market value of a bond rises above its face value (the initial price at issuance), the rate of return for investors in the secondary market decreases. This situation is commonly referred to as a “softening of bond yields.”
- Conversely, if the market value of a bond falls below its face value, the rate of return for investors in the secondary market increases. This is often described as a “hardening of bond yields.”
Factors Affecting Bond Demand and Market Price:
| Decreases Demand | Increases Demand |
| Market Price of the Bond Decreases | Market Price of the Bond Increases |
| Bond Yield Increases (Yield Hardening) | Bond Yield Decreases (Yield Softening) |
| Reasons: Increased Inflation, Sale of G-secs by the central bank under open market operations, Increased borrowings by the government (Increased fiscal deficit) | Reasons: Deflationary trends in the economy, Purchase of G-secs by the Central bank under open market operations, Reduced borrowings by the government |
| Loss to the Bond Holder | No Loss to the Bond Holder |
Impact of Bond Yield Hardening:
- Loss to Banks: Commercial banks in India, which hold a significant amount of government securities (g-secs) for statutory liquidity ratio (SLR) requirements and liquidity adjustment facility (LAF) purposes, incur losses when bond yields rise. This is due to the inverse relationship between bond prices and yields, forcing banks to book these losses.
- Loss to Mutual Funds: Mutual funds, which also hold substantial amounts of g-secs, experience similar losses when bond yields increase.
- Increased Cost of Borrowings: A higher yield on G-secs means that the government must offer higher interest rates on new borrowings. Corporates may also need to raise interest rates on their bonds in response to rising bond yields in the market. Indian banks, following long-term G-sec rates to determine lending rates, may increase their lending rates as well.
- Impact on Equity Market: Rising bond yields increase the opportunity cost of investing in equities, making equities less attractive for investors.
Q.1 Consider the following statements about bonds and bond yields:
- The face value of a bond is its market value.
- Bonds are issued only by governments.
- Bond yield is influenced by the bond’s current market value.
How many of the above statement/s is/are correct?
(a) Only one
(b) Only two
(c) All three
(d) None
ANSWER: A
Q.2 Consider the following statements about bond yields:
- “Softening of bond yields” occurs when the market value of a bond falls below its face value.
- “Hardening of bond yields” happens when the market value of a bond rises above its face value.
Which of the statements given above is/are correct?
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2
ANSWER: D
Q.3 Examine the role of the bond market as a vital component of the global financial system.
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