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Why is it that When equity markets are bullish we say the “Sensex” has “gone
up” or “Equity prices” have “gone up” or “NAVs” have “gone up”
BUT
when bond markets are bullish we say “yields” have “gone down”
Let me repeat
when bond markets move up we say the
“yields” have gone down whereas when
bond markets fall we say the “yields”
have gone up
Thus there seems to be an inverse
relationship between the markets and
the “yields”
HOWEVER
It is quite the opposite with Equity
Markets where the “SENSEX” is said
to go up with rising markets and go
down with falling markets
THUS
There seems to be a direct
relationship between the equity
markets and the SENSEX
AND why is the SENSEX used to
judge equity markets and why is it
that “Yields” are used to judge Bond
Markets?
I hope to unravel this mystery through
this lesson of mine
To get a proper understanding let’s
understand what is the role of markets.
Both Equity and Bond ( or Debt) markets
are platforms for organizations to raise
capital (or collect money) for running
their businesses
While in equity markets the business
offers its shares to investors who are
willing to take unlimited risks if the
business fails and hope for big gains
if the business succeeds.
When markets are positive or have a rising trend
or are bullish as is commonly spoken of, the
business can get more money for every share it
has to offer to investors who use the equity
market as a platform to invest
Now let’s see what happens in the
case of a Bond market.
In a bond market the business raises debt capital where the investors invest money for a fixed period at a particular
rate of interest.
When the bond markets are bullish/positive it
means there are enough investors in the
market who are willing to lend money.
In such a situation the business can expect
to raise capital (pick up money from
investors) at a lower interest rate or “lower
yield”
Hence we say that “when bond markets are
bullish the yields fall”.
Let me explain with an example.
Let’s say I issue a debt instrument (or debt
paper) of Rs. 100 each at 10% interest per
annum to the investor. This essentially
means that an investor who lends me Rs 100
for one year will earn Rs 10 at the end of the
year. Thus at the end of the year I will return
Rs. 110 (Rs 100 + Rs 10)
Now in a bullish market there are several
investors who want to invest and the
instruments or papers are relatively in short
supply. In such a situation, perhaps I would
find an investor who is willing to pay Rs105
for my debt instrument for which I had paid
Rs 100 to the original issuer for earning a
10% interest
In this situation I become the issuer to the
new investor who purchased the debt paper
from me for Rs 105.
Now let’s see at what yield I got to raise money.
To figure this out, we will have to see what the
investor (who bought the debt paper from me) earned
from the investment.
At the end of one year he would receive
Rs. 110 from the original issuer of the debt paper
( Rs. 100 [principal] + Rs. 10 [interest] ) because the
coupon rate or the rate mentioned on the debt paper
(debt instrument) is 10% of basic cost of Rs100
Hence the earning of the new investor works out to be
Final amount received – Initial amount investedRs 110 – Rs 105 = Rs 5
And the amount of interest he earns works out to(Profit/Invested amount) x 100
= {5 / 105}%= 4.7%
This is the yield that the investor gets from the debt
paper which he purchased from me in a bullish/positive
market
Thus I could raise capital at a lower yield of 4.7%
because of bullish market conditions.
Thus we see through this example that in
bond markets when the state of the
market is bullish the yields actually come
down and one is able to raise capital at
lower interest rate.
Thus we can say in a debt market I can
raise capital at lower yield in a bullish
market
But in the case of bullish equity markets I
would have got a higher price for my
shares
Thus in an equity market I can raise
capital at higher valuation
Thus there is a direct relationship between
bullish equity market and share price while in
the case of bond markets the relationship
between the bullish bond market and yield is
inverse in nature
Though this concept is simple many a times
people get confused and simply memorize
that “when bond prices go up yields come
down and vice versa”
Remembering without understanding the
concept is what makes education boring and
mundane.
I hope this lesson has succeeded in
clarifying this concept.
I will be glad to receive your feedback on
this lesson to understand if there any
gaps.
Your feedback will help me improve my
lessons going forward.
Also if you wish to demystify any other
concepts, please write to me about them.
Please send your feedback to
Your feedback is my reward.