Guys, please, help me understand this… What means bond A outperforms bond B? Interest rates change so that the yield of bond A is greater now than the one of bond B?
No. When rates would go down, both bonds would go up but Bond A would have a better price movement as compared to B and hence you’d make more money on A against B.
Think of it in terms of capital appreciation. Rates move in such a way that A’s value has grown more than B’s.
By the way, think carefully over your second question, and you tell me: do YOU think it means yield on A is now greater than yield on B?
Thank you. Well explained.
Thank you. Well explained, too. I think if the yield curve had not been inverted as a result of recent interest rate changes, the yields should be on the same side of each other. I mean, if yield of A was greater than yield of B, then it is true now as well.
wlfgngpck, is my understanding correct?
No. There are two things floating around here: 1) the yield at the time the bonds were bought and 2) the yield that they are at right now. For simplicity, let’s assume A and B have the same maturity and coupon.
Remember that yield is inversely related to price, so as yield goes up, bond prices go down and vice versa. So all else equal, saying the yield of A exceeds the yield of B either says 1) A was cheaper than B, or 2) B outperformed A (I suppose there’s a 3rd option where A’s yield increased less than B’s in which case A could outperform B, but I don’t think that was your intent in your question).
Note that if I let A and B have different terms, then the effect could be different (different durations and convexities) but generally I would expect that for A to outperform B in situations where A’s yield has decreased more than B’s or increased less than B’s.