How the bond price is determined in the open market? 

Introduction 

Indian bond yields were at 6.781% on 21st March 2022, while the rupee weakened as crude oil prices rose. The rupee’s value is closely correlated to crude oil prices because India imports more than 80% of its oil.  

India’s reliance on imported oil has become a major worry, as the cost of crude oil has gone up. It could hurt its trade and current account deficits. 

Bond yields continue to surge amid tensions between Ukraine and Russia and after the Fed raised interest rates. 

The bond’s price is quoted in terms of its yield. If yield changes, the bond price also changes.  

Bond prices are an economic indicator for traders and economists, who use the market to predict the economy and other related market factors.  

Factors affecting the bond price in the open market 

There are different types of bond markets in India. It can be divided into primary and secondary bonds markets. 

The prices of bonds, just like any other asset in a free-market economy (secondary bonds market), are determined by their demand and supply.  

However, numerous factors affect the demand and supply of bonds and thus their prices. Some of them are:  

1. Interest Rate Movements 

Interest rate movements affect the prices of instruments such as fixed income. India’s bond market is also affected by it.  

If interest rates tend to rise in an economy, the yield of bonds also increases, leading to a fall in the bond price. On the other hand, if the interest rates tend to decrease, the bond yield decreases and the bond price rises.  

This happens because if bond yields are higher for a new bond issue, but investors are getting a lower yield on the bond they are holding, investors will sell their bond. Thus the existing bond’s prices will fall.  

2. Term to Maturity  

The term to maturity of a bond can affect its price. For instance, when bonds get closer to their maturity date, their price gets closer to their par value. This is because when a bond reaches its maturity, the bondholders will be repaid the total face value of the bond.  

On the other hand, the more time for a bond to mature, the lower its prices. The rationale is that there is more interest rate risk and default risk with longer-term bonds.  

3. Credit Rating 

The bond issuer’s credit rating plays an essential role in deciding the interest rate offered on the bond and the bond’s price once it has been issued. 

If the bond issuer’s credit rating is low, the issuer will have to provide a higher interest rate to compensate the investor and vice versa. 

Further, if the bond issuer’s credit rating falls, once the bond has been issued and is trading on the secondary market, the bond’s prices will fall. 

4. External Factors  

External factors such as geopolitical tensions, political or economic instability, exchange rate fluctuations, natural calamities, etc., can also affect bond prices.  

Investors may flock to bonds during challenging times to protect their money instead of equity. Thus the bond prices will rise.  

Similarly, if the stock market is surging, bond prices tend to fall as investors choose to put their money in stocks instead.  

Conclusion 

Bond prices are one of the essential indicators of market health and can be a helpful tool for traders to find profitable trading opportunities.  

The price of bonds varies daily and is determined by the interaction between buyers and sellers, with several factors affecting that interaction.  

As an investor, it is crucial to determine the bond’s current price. With the bond price, investors can get a sense of how much they might earn if they invest in that particular bond. Knowing the price of a bond allows them to compare different bonds and find the best one for their needs. 

Published by ivankhanna

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