Unit 3 · Level 2 · Bonds & the boring half
The yield see-saw
A bond is a loan you make to a government or a company, in exchange for fixed interest payments (coupons) and your money back at maturity. The twist: bonds trade second-hand, and their PRICE moves opposite to market interest rates, like a see-saw. Say you own a bond paying 2%. If new bonds start paying 4%, nobody wants your stingy 2% at full price, so it drops until its effective yield competes.
Free to play. No ads, no token, no account needed to start.
What you get asked
Market interest rates rise. What happens to the price of existing bonds?
Your bond's coupon is frozen at the old rate while new bonds pay more. Buyers will only take yours at a discount deep enough to match the new deal.
Put the see-saw mechanism in order
Nothing about your bond changed; the competition did. Price adjusts so that old and new bonds offer buyers a comparable yield.
Bond yields and bond prices move in ___ directions.
This is the one sentence to tattoo somewhere handy: yields up, prices down, and vice versa. Every bond headline makes sense once you hold the see-saw in mind.
You hold a single government bond and rates rise, knocking its price down 10%. What happens if you simply hold it to maturity (and the issuer doesn't default)?
Price swings mainly matter if you sell early; a held-to-maturity bond delivers exactly what was promised. Bond FUNDS never mature, though, so their prices matter continuously.
Now the reverse: central banks CUT rates sharply. Your old bond pays a higher coupon than anything newly issued. Its price...?
The see-saw tilts both ways: falling rates make old higher-coupon bonds precious. That's why bonds rallied hard when rates were cut in 2008 and 2020, right when stocks were sinking. 🐜
The rest of this unit
The see-saw of yields and prices, and the year 'safe' fell double digits.