What does Bond Yield mean and What can be the impact of Rising Bond Yields?

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Bonds are one of the safest investment options in the financial markets. Both a risk-aggressive and a risk-averse investor can consider investing in bonds. So, irrespective of your risk appetite, it’s a great idea to understand the functioning of the bonds & invest in them

What does bond yield mean?

The returns earned by an investor on a bond are called Bond Yields. In the simplest form, the bond yield equals the coupon rate.  Other complex calculations of bond yield include Yield to Maturity (YTM), Effective Annual Yield (EAY) and Bond Equivalent Yield (BEY) that accounts for interest and compound interest payments.

When stockholders buy bonds, they generally lend issuers money. In return, the bond issuer pays the interest on bonds through the life of the bond and repays its face value upon maturity. The simplest formula for calculating a bond yield is to divide the coupon payment by the face value of the bond. This is known as the coupon rate.

The simplest version of yield is calculated by the following formula: Yield = Coupon Amount/Current Market Price.

Conventionally, economists diagnose the health of a country’s economy by studying indicators such as inflation, employment and GDP. However, a higher yield indicates a bigger risk as it implies that the yield offered by the bond is higher than its face value and there are chances that the company (or government)  might not be able to repay the capital.

Implications of rising bond yield

  1. Rising bond yields will have a negative effect on the NAV values of debt funds.
  2. Higher bond yields will impact the bank's bond portfolios.
  3. The Banks might have to increase the rate of interest.
  4. It will impact the equity valuations
  5. Government borrowing programs will get highly affected by the rise in bond yields.

In short, the rise in bond yields can have various repercussions for the investors and the financial market as a whole. An investor should have a thorough understanding of the bonds, how the yield is calculated and how higher yields can impact their portfolios. Understanding the basics will help you grow as an investor.