Bonds and Yields Simply Explained

What you will learn

• Basic bond terms: face value, coupon, maturity and yield.
• Why bond prices and yields move in opposite directions.
• What the yield curve is and what an inverted curve means.
• Why rising yields can pressure gold and growth stocks.

Explanation

A bond is a loan. The borrower (a government or company) promises to pay interest and repay the loan at the end. Key terms:

• Face value (or par value): the amount repaid at the end, for example €1,000.
• Coupon: the fixed interest payment, for example 3% of face value = €30 per year.
• Maturity: the date when the face value is repaid.
• Yield: the return you get based on the price you pay today.

After a bond is issued, it trades in the market and its price changes. The coupon stays fixed. So if you pay less for the bond, the same €30 is a bigger return on your money, and the yield is higher. If you pay more, the yield is lower. That is why price and yield move in opposite directions.

Why do prices change? Mainly because of new interest rates. If new bonds pay 4%, nobody pays full price for an old bond paying 3%; its price falls until its yield is competitive.

Important government bonds for markets include US Treasuries and, in the euro area, German government bonds (Bundesanleihen, often called Bunds), which are widely used as a benchmark.

The yield curve shows yields for different maturities, from short (months) to long (10 or 30 years). Normally, longer loans pay higher yields, so the curve slopes upward. When short-term yields are higher than long-term yields, the curve is inverted. Historically, inversions in the US have often come before recessions, but the timing has varied widely and it is not a reliable timing signal.

Why yields matter for other assets:

• Gold pays no interest. When yields rise, especially real yields (yields after expected inflation), holding gold has a higher opportunity cost. This tends to pressure gold.
• Growth stocks are valued on profits expected far in the future. Higher yields reduce the present value of those future profits, which tends to pressure their prices.

Worked example

Hypothetical example: a bond with €1,000 face value and a 3% coupon (€30 per year). We use the current yield = annual coupon ÷ price. This simple measure ignores the gain or loss at maturity; the full measure (yield to maturity) is more complex. Fees and taxes are excluded.

1. Price €1,000: current yield = €30 ÷ €1,000 = 3.00%.
2. Rates rise and the price falls to €900: €30 ÷ €900 = 3.33%.
3. Rates fall and the price rises to €1,100: €30 ÷ €1,100 = 2.73%.

Lower price, higher yield; higher price, lower yield. A holder who bought at €1,000 and sells at €900 has a price loss of €100 (−10%) before coupons.

Common mistake

Practice activity

On paper: a bond pays €40 per year (4% coupon on €1,000 face value). Calculate the current yield at prices of €800 and €1,250. Then: a one-year bond pays only €1,000 at maturity and costs €970 today. What is its yield?

Key takeaways

• Bond prices and yields move in opposite directions.
• The yield curve shows yields by maturity; an inverted curve has historically often come before US recessions, with variable timing.
• Rising yields, especially real yields, tend to pressure gold and growth stocks.
• Bonds can lose value through rising yields or default.

Next step

In the next lesson you will learn how risk-on and risk-off sentiment moves money between assets and why correlations change.