What is bond yield and how it is related to the interest rate on your loans

Understanding the tricky concept of bond yields

All the time, you must be hearing about bond yields going up or going down. What is the meaning of bond yields? Bond yields are a bit tricky to understand. Bond yield is the interest that a bond pays divided by the current market price of the bond. Take a 5 year bond that has a face value of Rs 100 and pays interest rate at the rate of 10% annually. So annual interest that this bond pays to the bond holder is 10% * Rs 100 = Rs 10. Now suppose today the market price of this bond is Rs 90. So the yield on this bond today will be Rs 10/ Rs 90 = 0.11 or 11%. Now tomorrow the market price of this bond rises to Rs 110. So yield on this bond tomorrow will be Rs 10/ Rs 110 = .09 or 9%.

Bond yield and bond price have an inverse relationship

The above example shows that when the price of a bond goes up, yield on it goes down. And when the price of a bond goes down, yield on it goes up. So when you read in the newspaper that yields on 10 year American treasury bonds have risen to a decade high of 5%, then this means that price of 10 year American treasury bonds have gone down to a decade low.

Bond yields on treasury bonds and corporate bonds

Both governments and businesses issue bonds to raise debt money. Government bonds are known as treasury bonds. So American treasury bonds mean the bonds issued by the US government. Bonds issued by companies and businesses are known as corporate bonds. Increase in yields in general on bonds means that interest rates are rising or markets are expecting that interest rates will rise in the near future. Decline in yields indicates that interest rates are coming down or are likely to come down.

Bond yields and interest rates that you pay on your golds loans, business loans etc

So when you hear that yields on bonds are going up in general, then this may also mean that interest rates that you are going to pay on the business loans, gold loans or personal loans that you are going to take are likely to go up. Because when interest rates rise in general, the interest rates that you pay on the loans that you take are also likely to go up.