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February 21, 2019

A Quick Look at the Bond Market and How it Works

The bond market is one investment market that is often a mystery to many. Indeed, this market is quite complicated with various different dynamics characterizing it. If you are looking to make an investment, or you simply want to understand the bond market better, then it is imperative that you familiarize yourself with some of the tenets of the market. You can do this by going over

the different aspects that explain how the bond market works. In this article, we will focus on understanding the bond market, how it works, and what moves it. Let us start with the basics.

The Forces that Move the Bond Market

When it comes to movements in the bond market, investors need to understand that expectations are in the middle of it all. Inflation and economic growth determine the payments that investors make. The payments made are fixed for a particular period of time and the expectations determine the number of payments. Yields and prices also need to be understood. As a rule, when the yields are high the prices are low and higher prices attract lower yields. This correlation is so because of the value that comes with the bond. An investor that buys a lowly-priced bond is thus promised of better yields and vice versa.

The Correlation Between Interest Rates and Yields

One of the most important questions that arise in the market of bonds is whether interest rates and yields are the same thing. On the surface, they can be the same thing because the two terms refer to value generated over time. On a more specific scale though, the interest rate generally refers to the bonds coupon rate. In addition, the market cost of money can also be analyzed in terms of interest rates. Rising prices in the market, for instance, lead to the lowering of yields which in turn lead to falling interest rates. The most important thing to note though is that yields determine the market rates and not the other way round.

The Essence of Treasury Prices and Yields

For investors, knowing the importance of treasury yields is critical. When it comes to trading in the bonds market, the term of the bond and the creditworthiness of the borrower are important. Bonds that take longer periods to mature are analyzed in terms of their term while those that take short periods are analyzed on the basis of the borrowers’ creditworthiness. Like in other markets, the interest rates are charged depending on the risks analysis that the investors do on the borrowers. Treasury bonds, also called government bonds, are much simpler in the sense that they are long term and no creditworthiness analysis is needed. Bonds yields rise when these bonds rise and fall when they falling.

The Effects and Correlations Between the Bond and Stock Markets

As investment markets, the bond and stock markets affect each other in various ways. To start with, falling interest rates are excellent for the stock market which depends on increased economic activity. But when the stocks are more attractive in the market, the attractiveness of the bonds market falls. When bond prices are rising, stock prices often rise and the yields in the market fall.

Where and How to Trade Bonds?

When it comes to trading bonds, there is no centralized trading platform. This is in stark contrast to the forex or stock markets. Bonds are bought over the phone from dealers and brokers. Information about prices is however available from various sources across the web and other platforms.

Why Short-term Treasury Yields are Sometimes Higher than Long-term Yields

While it is not the general trend in the market, long-term Treasury yields can sometimes be lower than short-term Treasury yields. In instances when this happens, the expectations on the market play the most important role. Sometimes, investors tend to buy long-term bonds at lower yields because they want to avoid the prospect of reinvestment. At other times, investors go for low yields because they expect the long-term Treasuries will go up based on scarcity.

In Summary

The bonds market is preferred by many long-term investors who want to put their money on a secure investment. There are many issues that characterize the bonds market. While the market is quite versatile and detailed, the investment choices to be made are often straightforward. The above breakdown of the market gives a quick view of what the market is all 

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