Economics
Bond Yield
Quick fact
When a bond's price rises above its face value, its yield falls below the coupon rate—a seemingly paradoxical relationship that is central to bond investing.
Why this is interesting
You know that when you buy a bond, you lend money, but did you know that the yield—the return you get—moves in the opposite direction of the bond's price? Why would your return shrink when the price goes up?
Read the full explanation
Understanding Bond Yield
Think of a bond as an IOU: you lend $1,000 today and receive fixed interest payments (the coupon) plus your principal back at maturity. The bond yield is the effective annual return you earn based on the price you actually pay. If you buy the bond at a discount (below $1,000), your yield is higher than the coupon rate because you also profit from price appreciation. Conversely, buying at a premium reduces your yield. This inverse relationship between price and yield is the key to understanding bond markets.
A deeper explanation
The mechanism behind bond yields lies in the fixed nature of the bond's cash flows. A bond promises specific future payments: regular coupons and the face value at maturity. When you buy a bond, you pay a price today for that stream of future cash flows. The yield is the discount rate that equates the present value of those future payments to the current price. If market interest rates rise, new bonds offer higher coupons, making existing bonds less attractive—their prices drop, raising their yields to compete. This inverse relationship is fundamental: bond prices and yields move in opposite directions. Yields also signal economic expectations: a rising yield often indicates anticipated economic growth or inflation, while falling yields suggest recession fears. Understanding this helps investors manage interest rate risk and interpret central bank policy moves.