Let me repeat

1. 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”

2. 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”

3. 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

4. AND why is the SENSEX used to judge equity markets and why is it that “Yields” are used to judge Bond Markets?

5. I hope to unravel this mystery through this lesson of mine

6. 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

7. 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.

8. 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

9. Now let’s see what happens in the case of a Bond market.

10. In a bond market the business raises debt capital where the investors invest money for a fixed period at a particular rate of interest.

11. 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”.

12. 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)

13. 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

14. In this situation I become the issuer to the new investor who purchased the debt paper from me for Rs 105.

15. 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

16. Hence the earning of the new investor works out to be Final amount received – Initial amount invested Rs 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.

17. 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

18. 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

19. 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

20. 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.

21. I hope this lesson has succeeded in clarifying this concept.

22. 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 professor@tataamc.com Your feedback is my reward.