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

professor@tataamc.com

Your feedback is my reward.