The Bond market gives investors a High Five

By Stephen Bennie

I’m sure I’m not the only person whose eyes tend to glaze over at talk of an inverted yield curve or what’s happening with the pricing of 2-year break evens. But big things have been happening in bond land in recent weeks which I thought merited some discussion, albeit by a non-expert.

Taking a step back, bonds are in essence a simple investment. You lend to an entity, generally a country or a corporate, some money for typically a set number of years, during which time you will be paid interest until maturity (the end of the agreed period) at which point you should get your original loan back. The two main variables of the deal between lender and borrower are the number of years and the amount of interest paid. The other pertinent aspect of the deal is how creditworthy the borrower is.

So far, hopefully, so good. If you buy and hold a bond to maturity, you get exactly what was agreed to on day one, all going to plan. However, if you decide to sell before maturity, you may find that you make a gain, or a loss, on your bond, as it gets “marked to market”. If interest rates have moved lower, you will make a gain, as your interest rate is better, this gain is amplified by the number of years, duration, still left by that higher interest rate, the more years the merrier. The flipside is true of rising interest rates, which will mean a loss and again the greater the duration the greater the loss. These fluctuations are referred to as interest rate risk.