I am a bit confused about Book 3-session 6 regarding the effect of economic growth on bond yield. When I worked on the practice questions at the back of the session, question 17 indicated that GDP increase will have a negative impact on bond yield. However, GDP growth is a result of lower interest rates, which will lower bond price and increasing bond yield. Am I wrong? Thanks.
Lower interest rates = lower bond yields lower bond yields = higher bond prices
There is an exception to that rule of thumb. High rates = high yields = low bond price. But, if rates go high enough where market participants anticipate that it will slow the economy, yields will decrease and bond prices will increase.
former trader Wrote: ------------------------------------------------------- > There is an exception to that rule of thumb. > > High rates = high yields = low bond price. But, > if rates go high enough where market participants > anticipate that it will slow the economy, yields > will decrease and bond prices will increase. i.e. inverted yield curve. Rates on short term fixed income (ie T-bills) would still be relatively high though.
high inflation may be factor also. a sharp rise in short term rates may be accompanied by a rise on the long end. What questions are you talking about? Schweser or the CFA books? I couldn’t find Q17 that you were talking about.
c as the expands or GDP increases the monetory policy will become more restrictive and the central Bank will raise interest rates to prevent the economy from overheating. So GDP rise is negative for bond yields in the sense that the yield goes up and the price of the bond falls down
It really all depends on which stage of the business cycle we are talking about here. In a recovery, interest rates and bond yields will most likely be low. This will allow for GDP growth. In the early stages of economic expansion, interest rates and bond yields will rise as money flows out of the bond market and into the stock market. The Fed will start raising interest rates in order to curb inflation. As a result, short term rates will increase and long term rates may decrease as the yield curve flattens (or invert) and prospects for further growth diminish. More money will flow out of equity and into debt securities (flight to quality) once the recession fears enter the market. Bond prices will rise and yields will fall further. Eventually the Fed will start cutting interest rates to stimulate the economy, and the yield curve will steepen. So early GDP growth can be accompanied by rising yields, but eventually will be followed by lower yields when the fed starts fighting inflation.
More money will flow out of equity and into debt securities (flight to quality) once the recession fears enter the market. Bond prices will rise and yields will fall further. isnt this similar to the current market situation ? Money seem to be moving into high grade corporates …
Thats what happened about a month ago. Since then, the stock market has rebounded slightly, bond prices dropped and yields went back up. The yield on the 10 yr has risen 30 bps or so in the past month.
theoreticaly for the bond prices to drop there would have to be rise in Interest rates …since that has not happened is this price drop due to a sell off or is there something else behind it ?
Exuberance and inflation expectations. The bad news (ie recession) was already priced into the market. Bond prices were too high. Fed policy, incoming tax rebate etc have probably increased inflation expectations. Inflation is very bad for long term bonds. Market also probably gained some confidence in the thought that the fed will fight recession so that maybe it won’t be as bad as what was originally priced into the bond market. That is my opinion anyways.