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Why in news?

  • The yield on the most-traded 10-year government bond spiked 20 bps (basis points) on 11th May 2020, after the government announced it would increase its market borrowings by more than ₹4 lakh crore for FY21.
  • Intraday, yield rose 27 bps, the sharpest intraday surge since February 2017.
  • As per the new revised FY21 borrowing calendar, the central government will now borrow ₹6 lakh crore in the first half of the current financial year against the ₹4.88 lakh crore budgeted initially.
  • Until RBI announces open market operations (OMO) to purchase government securities to address the supply glut, there would be pressure on yields.

What are Bonds?

  • A bond is like an IOU. The issuer of a bond promises to pay back a fixed amount of money every year until the expiry of the term, at which point the issuer returns the principal amount to the buyer.
  • When a government issues such a bond it is called a sovereign bond.
  • Governments issue bonds as part of their borrowing programme.
  • By purchasing a debt instrument like bond, an investor becomes a creditor to the corporation (or government).
  • A bond is a financial security issued by a borrower to avail long term funds.
  •  Thus a bond is like a loan: the holder of the bond is the lender (creditor), the issuer of the bond is the borrower (debtor). The primary advantage of being a creditor (by purchasing bonds) is that he has a higher claim on assets than shareholders do. That means, in the case of bankruptcy, a bondholder will get his money back before a shareholder.
  • However, the bondholder does not have a share in the profits of a company.

What is Bond Yield?

  • Bond yield is the return an investor realizes on a bond.
  • The bond yield can be defined in different ways.
  • Setting the bond yield equal to its coupon rate is the simplest definition.
  • The current yield is a function of the bond’s price and its coupon or interest payment, which will be more accurate than the coupon yield if the price of the bond is different than its face value.

As bond prices go down – bond yields go up

  • Now, seeing the increased bond yield, more and more buying of the bonds will ensue leading to increased demand of the bonds and we know that increased demand will command a higher price.
  • So, an increased demand will propel the bond prices up thereby leading to a reduction in bond yield, which will further lead to reduction in demand.

-Source: The Hindu

December 2023