Bond Yield, 10 Year Treasury Bonds

Definition

What is Bond Yield, 10 Year Treasury Bonds?

U.S. Treasury bonds are used to finance borrowing by the U.S. government. Someone who buys a 10-year Treasury bond is lending their money to the U.S. government for 10 years. In return, the government pays the owner of the bond interest, sometimes called the coupon rate. The bond can be sold prior to its maturity. Since the prevailing interest rate when a bond is re-sold will usually be different than the coupon rate, the price of the bond must adjust so that the financial return (called "yield") is consistent with prevailing interest rates. Current bond yield is calculated by dividing the annual coupon payment on the bond by the current bond price:

(coupon payment)/(current bond price)

For example, suppose a bond that originally cost $10,000 had a coupon rate of 10 percent, paying $1000 per year. If prevailing interest rates fall to 5 percent, then this bond becomes considerably more valuable, and its price in the (resale) bond market will rise to $20,000 in order for the bond yield to equal the prevailing 5 percent interest rate. Thus bond prices move in the opposite direction of interest rates, which reflects the opportunity cost of investing in bonds when compared to other interest bearing securities such as Treasury Bills or equity investments, such as stocks.

Since the U.S. government is considered a risk-free borrower, the Treasury bond yield serves as a benchmark risk-free interest rate. As a reflection of prevailing interest rates and inflation, Treasury bond yields have a powerful influence on the economy. If inflation (or inflationary fears) grow, then prevailing interest rates must also rise in order to maintain adequate real rates of return. Thus inflation (or inflationary fears) are directly reflected in Treasury bond yields. The Fed can try to head off inflation by engaging in contractionary monetary policy to raises prevailing interest rates. As interest rates rise it becomes more expensive for businesses to borrow money for purposes of capital investment, and for consumers to borrow for home and durable-good purchases. Thus higher interest rates reflect inflation and tend to slow economic growth. Moreover, by raising corporate borrowing costs, higher interest rates tend to cause stock prices to decline.

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