Things to know about bond, bond yields and their relationship with the equity market

A company needs funds to finance their projects for expansion or to reduce their debt generally, So they have two options mainly to go with equity or by debt.

In debt, it has the option to borrow money from banks/financial institutions or go directly and raise it from the public by issuing the bond.

According to Investopedia, A bond is a fixed income instrument that represents a loan made by an investor to a borrower (typically corporate or governmental).

In the case of raising funds from equity, the company shares its equity and makes the investor part-owner of the company via stocks, similarly, they share the debt with investors via bonds. Bonds are units of debt issued by the company and traded like stocks.

Bondholder gets regular interest payment on the face value(Bond's Price). This interest rate is called the coupon rate which remains fixed till maturity.

Since bonds are tradeable, the return that it generates is called bond yields.

Bond yields are returns that we get when we buy a bond from the secondary market.

For example, an Investor bought a 10- year bond of ₹10,000 FV with a 6% coupon rate

So, the investor will get a ₹600 annual interest payment.

Now in the secondary market prices falls to ₹6000 so yield will become 600/6000 = 10%

and when prices rise to ₹12000 yields will be 600/12000 = 5%.

From the above changes in price and yields, it is clearly visible that price and yields have an inverse relationship that means if price rises, yields fall and if price falls, yield rise.

Now let's try to understand how it affects the equity market-

When bond prices fall it becomes a lucrative investment opportunity for the equity investors so they pull out the money from equity ( that means supply increases in equity) and invest the same in the bond market.

This is not the only reason there are many, another popular one is when an analyst does the DCF valuation, he uses the cost of capital. The cost of capital is a weighted average of the cost of equity and the cost of debt. So for the debt part, he uses a 10year G-sec yield that means in simple terms if yield rises it will give a negative impact on the valuation of the company and make equities unattractive.

This is how they are connected with each other.

Happy reading.....!!!!!!