When an entity wants to borrow money, it will issue a bond as a “IOU.”
These entities, such as governments, towns, or international corporations, require a large amount of capital to operate, thus they frequently borrow from banks or individuals like you.
When you own a government bond, the government effectively borrows money from you.
“Isn’t that the same as owning stocks?” you could ask.
One significant distinction is that bonds often have a stated period until maturity, after which the owner receives repayment of the money he loaned, known as the principle, at a preset set date.
In addition, when an investor buys a bond from a corporation, he is paid at a certain rate of return, also known as the bond yield, at predetermined time intervals.
These recurring interest payments are frequently referred to as coupon payments.
Bond yield refers to the rate of return or interest provided to bondholders, whereas bond price refers to the amount of money paid for the bond.
Bond prices and yields are now inversely connected. Bond yields fall when bond prices rise and vice versa.
To help you remember, here’s a simple illustration:
Always remember that currency price behavior is governed by inter-market interactions.
Bond yields are an excellent indicator of the strength of a country’s stock market, which raises demand for the country’s currency.
For example, US bond rates reflect the performance of the US stock market, which in turn reflects demand for the US currency.
Consider the following scenario: When investors are concerned about the safety of their stock investments, demand for bonds typically rises.
Bond prices rise as a result of the flight to safety, but bond yields fall due to their inverse connection.
A growing yield is good for the dollar. A declining yield is negative for the dollar.