Bonds and Treasury Yields: How They Are Related

In this article, we will show the simple relationship between bonds and treasury yields.

Bonds are debt instruments that are used by governments and companies to borrow money from investors at cheap rates. Instead of borrowing from lending institutions at exorbitant rates and under conditions of repayment which may be too stringent for the borrower, it may be more convenient for the borrower to approach investors through the bond market.

Bonds are known by several names in several countries. In the US, Nigeria and some other countries, they are known as Treasury bills and Treasury Notes.

Treasury yields refer to the percentage interest rate that a bond investor can expect to earn for his bond investments. In other words, the treasury yield is the payment on a bond. Treasury yields can fluctuate on the market, even though when an investor buys a bond, the payable rate at which the negotiation is settled on will not change until the bond matures.

Different countries have different yields on their bonds. In addition to the present yield, it is important for investors to know what the annual yield changes have been, and the day to day and month to month changes in the yield rates have also been. This information can make the difference between making money on a bond investment, and buying a bond which will eventually get blown off by falling yields or falling prices as a result of inflationary pressures.

Below is a table showing the treasury yields of different countries.

(Source: © 2012 Trading Economics)

The data clearly shows the following information:

a)     Treasury yields are not steady, even though the interest rates that bond investors earn on their investments usually do not change.

b)     The higher yields are seen with countries where the risk of default is higher. This explains why Greece occupies the number one position on this list.

c)     Another factor to look at is the rate of annual change in the treasury yield of a government bond. If we look at this list, we can see that the greatest swings are seen in countries with sovereign debt crises. So Greece, Portugal, Ireland and Brazil are tops in terms of changes in the yields.

Using this information, we can conveniently identify the factors that affect yield rates:

a)     Inflation

What does inflation do to bond prices and yield rates? If the inflation rate exceeds the treasury yields that a bond is expected to pay the investor, the obvious effect is that the earnings from the bond will be worth less in future than it would have been. In order to militate against inflation risk, traders should avoid holding bonds for a very long time. With the global uncertainty in the financial markets that have been experienced for some years now, it really makes no sense holding a 30 year bond in this day and age.

b)     Credit rating

Credit ratings are used to judge the ability of a bond issuer to pay back. If credit ratings of a bond issuer are low or are cut from higher levels, the treasury yields will have to be increased as an incentive for investors to take a chance on that bond. If ratings improve or the bond issuer is able to access finance to enable it settle its obligations, the treasury yield will fall. This explains why Greece’s bond yields were as high as 24% last year, but has fallen to about 16% as it has accessed bailout money from the ECB and other lenders.

c)     Interest rates

If interest rates are increased to a point where it exceeds a bond holder’s yields, investors will flock more to the bond with higher rates and the value of the present bond will drop, leading to a bond’s price being discounted.