The confusion often comes from how bond yield and bond price relate. While many think they move together, they actually move in opposite directions. Understanding this bond price yield relationship is key to managing your bond investment.
A bond is like an IOU (I owe you). When a government or corporation wants to raise money, they issue a bond. This document details the principal amount, coupon interest rate and repayment date.
Bond investments offer stable returns and diversify your portfolio. Because you can trade bonds in the second-hand market before they mature, the yield you earn may differ from the agreed interest when it was issued.
To understand bond market performance, investors look at bond yield. It's the return you expect if you hold a bond until it matures. This value depends on the bond price in the secondary market.
The formula below helps explain why bond fund returns might drop even in a 'rising' market:
Because the coupon interest stays the same, bond yield and bond price go in an opposite direction. When bond yield goes up, the bond price drops, and this causes a fall in bond fund performance.
Member A bought a bond from the issuer on the issue date.
The coupon rate is the promised interest rate from the issuer when a bond matures, and this doesn't change.
After 1 year, Member A will receive HKD1,050 (the sum of a principal of HKD1,000 and an interest of HKD50). If Member A holds the bond from the issue date to the maturity date, the bond yield equals coupon rate, which is 5% in this example.
However, bonds can be traded in the secondary market before the maturity date. A bond's price in the secondary market (current market price) is affected by factors such as credit rating, demand and supply, which fluctuate before the bond matures.
Member B bought the same bond on the secondary market.
So, when the bond price goes up, the bond yield drops:
|
Case
|
Purchase price of bond | Tenor | Coupon rate | Bond yield |
|---|---|---|---|---|
| Member A | HKD1,000 | 1 year | 5% | 5% (HKD50 divided by HKD1,000) |
| Member B | HKD1,100 | 1 year | 5% | 4.55% (HKD50 divided by HKD1,100) |
Case
|
Member A | Member A |
|---|---|---|
| Purchase price of bond | HKD1,000 | HKD1,000 |
| Tenor | 1 year | 1 year |
| Coupon rate | 5% | 5% |
| Bond yield |
5% (HKD50 divided by HKD1,000) |
5% (HKD50 divided by HKD1,000) |
Case
|
Member B | Member B |
| Purchase price of bond | HKD1,100 | HKD1,100 |
| Tenor | 1 year | 1 year |
| Coupon rate | 5% | 5% |
| Bond yield |
4.55% (HKD50 divided by HKD1,100) |
4.55% (HKD50 divided by HKD1,100) |
Bond yield allows you to compare the actual returns of a bond with that of other investment tools, such as savings.
Coupon rate is the promised return by the issuer, so it remains unchanged until the maturity date.
With a constant coupon rate, when bond yield rises, the bond price goes down. Net asset value and returns of bond funds that invest in investment grade bonds will also go down.
So, when you read a bond market outlook suggesting the bond market is going up (generally speaking, when bond yield is rising), be aware this doesn't necessarily mean positive returns for your bond fund.
MPF is a long-term retirement investment tool. You're not encouraged to time the market.
Remember that bond prices and yields move in opposite directions: when bond yields rise, bond prices fall. When managing your MPF, avoid reacting to short-term market changes. Instead, focus on steady contributions and diversification for long-term growth.
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Investment involves risks. Past performance is not indicative of future performance. The value of financial instruments, in particular stocks and shares, and any income from such financial instruments, may go down as well as up. For further details including the product features and risks involved, please refer to the MPF Scheme Brochure.
The content shared in this article should not be viewed as investment recommendation and advice. You should seek professional analysis and advice before making any decisions related to the information shared in this article.
