Bonds and interest rates

Hi, welcome to this new video. Today the topic is a little different from stocks and ETFs and REITs because we will speak about bonds and also how interest rates can affect the bond prices. Now let's start with the concept of bond. So what is a bond? When you buy a bond, you first have to pay an amount of money. This is called face value. Let's say for example, we have a bond bond X. Okay? So you have the face value, that is what you pay at the beginning. Let's say for example is 100k US dollar. And then there is percentage that you get is the coupon. So for example, you may have a coupon of 5% for here. And in this case, since we are paying 100k, 5% will be 5k for year. That's what you get for buying the bond and then you have also maturity. So when will you have back your money? For example, let's say 10 years. Okay, so again we have the face value, how much you pay the bond when you buy it, the coupon, that is 5% and 5K per year. And then the maturity 10 years in this case. And is the time that you have to wait to get back your 100k, of course, hoping that the company or the government, whatever is issuing the bond will not fail before that. Now there is also another interesting concept for bonds that is yield. Okay? And yield in this case is 5% at the beginning. Okay, so here is what we get every year. So the 5k over the price, right? So is the price we pay for the bond price paid over the coupon. Okay? Now if you buy the bond at the beginning, of course you get this 5%. That is what they give you. But the price of the bond can change. Okay? It starts from this and at the end you will get after 10 years the same amount. But during these 10 years, this price can go up and down. And this will be often determined by the interest rates that we will discuss in a short while. But how is this important when we compute the yield? Here is the thing. If, let's say at some point, let's say at here, okay, after the bond has been issued, the price is 95k USD. What is the yield? Well, we still get 5% of the face value. That's important. We still get 5% of the face Value. That is 5k, right? But this time we are getting 5k and we are paying 95k. So what we get if you do the computation should be something around 5, 26%. So in other words, when the Price drops, the yield increases. And this is similar for REITs. When the price drops and they pay the same amount of dividends, then the yield increases. What if, for example, let's say the price increases? For example, let's say the price goes to 110k USD, so you have to pay at a premium. While in this case the yield is what it will be again the 5K. So remember, this is very important. You get a coupon based on the face value, not based on the current price. So you still get 5k regardless of the price you pay. But if you now pay 110k, then the yield you get is something around 4, 55%. So if you buy at the beginning, you have 5%. If you buy when the price is below the face value, you have higher yield. And when the price is above, you have lower yield. So this is the first thing to understand when we discuss about bonds. Now, there is something else that I mentioned about interest rates. Why? Because. Let's say that at year two. What happens at year two? Let's do this. Suppose that here too they issue a new bond called bond Y with the same face value, 100k USD. Okay. But this time they give you. 7%. Okay, 7% may be. Why? Because the interest rates are higher. So if the interest rates are higher, also the bond can give you more. What does it mean? It means If I have 100k and I want to buy this bond, I will get 7k for here. Okay. And we assume again the maturity is also 10 here, we get 7k for here. Now you will realize that if I have the choice between a bond like that, that pay me 7k and I have to invest 100k and a bond like that, where I have to invest 100k, I get 5k. Of course, I will take this, right? So what happens in this case to bond X? Well, as you can imagine, in order to match this kind of yield, the price is supposed to drop, right? In other words, if in this case, now that we have this 7%, our bond X price should drop. Why? So we get up a better yield for bond x, possibly around 7%. Now, the pricing of bond is not easy. In other words, what would be the price such that the yield of bond X is similar to that of the new bond Y and Y is not easy because we have to take into account many things. For example, we have to take into account the fact that the bond is paying us some coupon every year. But the value of the money is not the same every year. So for example, 5k paid now don't have the same value of 5k in 5 years, right? Because the money later is worth less because inflation and all these things. So there are some models that take into account the whole amount of cash that you get from your bond and then discount it back at the present time and then value that in order to get a yield similar to the new bond. And I will put a link below the video if you are interested. You can check that. But the main point here is this. First understanding this concept, the face value, The face value. And remember that you get this amount of money at the end as well, the maturity. So when you get that money and the coupon, how much you get every year, even though some bonds pay every six months. But that's another story. And then the other interesting point is the yield that at the beginning is 5%, maybe like in this case, but then it can change according to the price of the bond. So the coupon you get is always the same. But if you pay more or less the bond, then the yield you get can be higher or lower. And eventually when interest rates can affect the yield of the coupon that you get for new bonds, this will also impact the price of the existing bonds. How we have seen here the example, right? Because if a new bond is more interesting from the point of view of the yield, then in order to make an old bond comparable, we need to lower the price at the same time. If the new bond, for example, got let's say 3%, then what happened to the old bond? Well, the price will go up. Why? Because now the interest of the old bond is much more attractive. So people will want to buy and this will drive the price up. And what will happen is that eventually if the price is providing a yield that is similar to the new bond, it will make not much difference choosing one or the other. So with this I would like to conclude this short lesson on bond. And I hope this clarifies some of the concepts, some of the terminology for bonds and also this idea that interest rates can affect the bond price. So when interest rates go up, then the new bond will give you more money. Then the old bond, to be competitive, should be sold at a discount. And at the same time, when the interest rates are going down, then the old bond are more competitive and so the price is supposed to increase. And with that again, I would like to conclude. Thank you for watching. If you have any question, you can write me a comment on the video and see you next time.