Bond Yields

Definition

Bond yields refer to the effective interest rate paid on a bond. It is the return an investor receives by holding a bond to maturity and is a crucial factor in households' decisions to supply financial capital.

5 Must Know Facts For Your Next Test

1. Bond yields are a key determinant of the rate of return on fixed-income investments for households.
2. Yields move inversely to bond prices, so when yields rise, bond prices fall, and vice versa.
3. The yield curve, which plots yields across different maturities, provides information about market expectations for future interest rates.
4. Changes in the Federal Reserve's monetary policy, such as adjusting the federal funds rate, can significantly impact bond yields.
5. Households consider bond yields when deciding how to allocate their financial capital between bonds, stocks, and other investment options.

Review Questions

• Explain how bond yields are related to the concept of households supplying financial capital.
  • Bond yields are a crucial factor in how households supply financial capital. When households decide to invest their savings, they must consider the expected rate of return on different investment options, such as bonds. The bond yield, which represents the effective interest rate paid on a bond, directly affects the return households can expect to receive by holding a bond to maturity. Households will allocate their financial capital to bonds based on the relative attractiveness of bond yields compared to other investment opportunities, such as stocks or real estate.
• Describe the relationship between bond prices and bond yields, and explain how this relationship affects households' investment decisions.
  • Bond prices and bond yields have an inverse relationship, meaning that when bond prices rise, bond yields fall, and vice versa. This is because as bond prices increase, the effective interest rate (yield) on the bond decreases. Households must consider this relationship when deciding how to allocate their financial capital. If bond yields rise, it makes bonds more attractive relative to other investment options, as households can expect a higher rate of return on their bond investments. Conversely, if bond yields fall, households may shift their financial capital away from bonds and toward other investment opportunities that offer higher returns.
• Analyze how changes in the Federal Reserve's monetary policy can impact bond yields and, in turn, influence households' decisions to supply financial capital.
  • The Federal Reserve's monetary policy, such as adjusting the federal funds rate, can have a significant impact on bond yields. When the Federal Reserve raises interest rates, it generally leads to an increase in bond yields, as the cost of borrowing money becomes more expensive. This makes bonds more attractive to households, as they can expect a higher rate of return on their bond investments. Conversely, when the Federal Reserve lowers interest rates, bond yields typically decrease, making bonds less attractive relative to other investment options. Households must closely monitor changes in the Federal Reserve's monetary policy and the resulting impact on bond yields when deciding how to allocate their financial capital between bonds, stocks, and other investment vehicles.

Related terms

Bond Price: The market price of a bond, which fluctuates inversely with the bond's yield.

Yield Curve: A graph that plots the yields of similar-quality bonds against their time to maturity.

Interest Rates: The cost of borrowing money, which directly influences bond yields.