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Q1. Consider the following statements with reference to bond yields:
i) Bond yield is the effective rate of return that an investor earns if the bond is held until maturity.
ii) It moves inversely with the market price of the bond.
iii) Bond yields are unaffected by domestic inflation expectations or the monetary policy decisions of the Reserve Bank of India (RBI).
iv) When bond yields rise significantly, it generally exerts downward pressure on equity markets because higher yields make fixed-income securities more attractive relative to stocks.
Which of the statements given above is/are correct?
- Statement 1 – Correct Bond yield represents the total return an investor would receive by holding the bond till its maturity, assuming all payments are made as scheduled. Statement 2 – Correct There is a fundamental inverse relationship: when the market price of a bond rises, its yield falls, and vice versa. This is because the fixed coupon payments become relatively smaller or larger compared to the bond’s current price. Statement 3 – Incorrect This statement is wrong. Bond yields are highly sensitive to inflation expectations. If inflation is expected to rise, investors demand higher yields to compensate for the loss of purchasing power. Statement 4 – Correct Higher bond yields increase the opportunity cost of investing in equities. As safer government bonds offer better returns, institutional and retail investors often shift money from stocks to bonds, leading to selling pressure and potential decline in stock prices.