Home » News » Personal Finance»Fixed Income - Bonds
Mar 13, 2013, 04.16 PM | Source: Moneycontrol.com

How does rise/fall in repo rates impact Bond yields?

RBI kept the interest rates unchanged on concerns of growth & liquidity issue. As bond shares inverse relationship with the interest rates, it becomes important to understand the concept clearly before investing in fixed income. Financial advisor Arjun Parthasarathy enlightens us on how the yield curves behave with the rise/fall of interest rates.

The yield curve plots the yields of fixed income securities with their maturities. A normal yield curve is upward sloping on the theory that fixed income securities with shorter maturities trade at yields lower than that of yields of fixed income securities with longer maturities. For example a five year government bond yield should be lower than a ten year government bond yield, as per theory. In practice, yield curves change shape due to various factors, and there are times when the five year government bond yield is higher than the ten year government bond yield and when this happens the yield curve is said to be inverted.

India has been facing inverted yields curves in the government bond market, corporate bond market and interest rate swap market for over a year now. The chart below shows the inverted nature of yield curves for government bonds, corporate bonds and interest rate swaps (OIS or Overnight Index Swaps).

 

 

 

Source: CCIL

Government bond yield curve is inverted over the five over ten segment of the curve with the five year government bond yields at 8.24% levels higher than ten year government bond yields at 8.11% levels. This inversion can to some extent be explained by the fact that the ten year government bond is a new benchmark on the run bond, which is the 8.15% 2022 bond while there is no five year benchmark bond that has been issued recently. However the fact remains that even if a new five year bond was to be issued, it will trade at similar or higher yields than the ten year bond.

Corporate bond yield curve is inverted with one year corporate bond yields at 9.6% levels trading higher than five and ten year corporate bond yields of 9.35% to 9.40% levels while the OIS curve is inverted with the five year OIS yield at 7.30% levels trading below one year OIS yield of 7.80% levels.

The reason yield curves are inverted is that repo rate is at 8% and banks are borrowing on a daily basis from the RBI at repo rates. Liquidity is in deficit and RBI has kept the repo rate at 8% in its June policy review leading to short maturity bond/swap yields trading levels higher than long maturity bond/swap yields. The longer maturity bond/swap yields are lower than short maturity bond/swap yields on expectations of RBI reducing repo rates down the line and liquidity becoming easier going forward.

At some point of time in the future the view of the market will turn out right i.e. RBI will cut repo rates and liquidity will ease. Once repo rates are cut and liquidity eases, the yield curves will steepen with short maturity bond/swap yields trading at levels below longer maturity bond swap/yields.

The shift in yield curves from inverted to steep will benefit investors at the short end of the yield curve. Investors investing in bonds of maturities of one and five years or investing in short term funds can see good gains as yields on such bonds fall. However the timing of the steepening of the yield curves is not certain as RBI is still holding on to rates and liquidity is still negative.

The actions of the RBI point towards steepening as it has cut repo rates by 50bps in its April 2012 policy and has indicated further cuts ahead on growth issues. RBI is buying government bonds (it has bought Rs 67,000 crores of bonds April till date and is buying more through bond purchase auctions) and this bond purchases will lead to liquidity deficits easing down the line.


Arjun Parthasarathy is the Editor of  www.investorsareidiots.com a web site for investors. 

ADS BY GOOGLE

Ask the Experts

Get your Personal Finance queries answered

  • Q

    If I put Rs 2 lakh in PPF, how much tax rebate I will get?

    A

    As per the existing guidelines and rules a person cannot deposit more than 1.5 lacs in one PPF account. However you can deposit money in the...

  • Q

    Interest rates are going to go down. And all my fixed deposits will be maturing next year. I will have to renew my fixed deposits next year at lower rate of interest. What is the way out?

    A

    Interest rates keep fluctuating due to various micro- and macro- economic factors. There is never an ideal rate of interest. In a high inter...

  • Q

    I want to buy online term life insuance plan. Which is the best one? Should I go for single premium or regular premium policy?

    A

    Single premium term insurance policies don?t make much sense. Why pay such a large amount at one go when you have the option of paying in sm...

  • Q

    I want to invest some money with at least ten years view. I dont want share market risk. Can I invest in NSC? Is there any other investment option?

    A

    NSC or National Savings Certificate is a safe investment scheme offered by the Central Government. It is an ideal option for investors with ...

  • Q

    Is it a good idea to invest in asset allocation funds? if yes, please suggest some good fund to invest money. I am 35 years old and can invest Rs 10000 per month.

    A

    Asset Allocation Funds are for those investors who want to take an exposure into different asset classes but do not wish to create their own...

  • Q

    My CA says that I have to pay tax on interest accrued on my FD of Rs 20 lakh. I have submitted form 15H in all banks. Is it necessary to pay tax in this case?

    A

    In case of interest on fixed deposits which is taxable under the head ?Income from other Sources? a taxpayer has two choices. Either you can...

  • Q

    Please suggest a good investment option of land in South India. I want to buy a land parcel of around 2 acres.

    A

    If you take a look at the South Indian real estate market, Bangalore has emerged as a clear winner. Due to the strong presence of IT/ITeS an...

  • Q

    I want to invest Rs 20000 per month. I have identified Reliance Small Cap Fund and DSPBR Micro cap fund for investment. I can hold to investments for two years. Is it a good idea to invest in these schemes? How much returns I will be getting?

    A

    If you are an aggressive investor, you can consider investing in either of the 2 funds.DSPBR Micro Cap My suggestion is that if you are inve...

  • Q

    I want to save my money for retirment Please suggest a good insurance policy

    A

    For retirement it is advisable to use multiple investment instruments and not just life insurance policies. If you have 15 years or so for r...

  • Q

    IS IT a Good time to invest in GOLD ?

    A

    Currently the outlook for gold is bearish/negative. However if you are planning for a long-term investment in gold it is ideal to invest the...

  • Q

    I have retired from my job in November. I have got Rs 48 lakh from my employers, by way of epf, gratuity and other benefits. Should i invest in senior citizen scheme of LIC? How about pension plans from LIC?

    A

    1. You can invest Post office Senior Citizen Scheme. 2. You also should invest lumpsome in MIP in post office and get monthly interest. 3. K...

  • Q

    I want to save Rs 1 crore for my retirement when i turn 60. Now I am 42 years old and have fixed deposits worth Rs 18 lakh.What should I do to reach Rs 1 cr mark?

    A

    start investing a minimum 5000 per month in mutual fund and increase 10% to 20% every year....

  • Q

    I want to save on my utility bills and fuel expenses.Please suggest a good credit card for me.

    A

    Yes, you will be able to save on Utility bills and fuel expenses through the cash back schemes offered by some of the credit card companies....

  • Q

    Suggest couple of equity mutual funds for me. I am keen to invest Rs 25000 per month for next couple of years. I can remain invested for at least five years?

    A

    Asset Allocation Funds are for those investors who want to take an exposure into different asset classes but do not wish to create their own...

  • Q

    I am a senior citizen.I received interest of Rs .1,70,000/- on FD.I have duly filled 15G form.I have NO other source of income.Have I to pay Income tax on this interest or can it be excempted?

    A

    Sir, please note if you are less than 80 years but more than 60 years of age, your total income upto Rs 3,00,000 is exempt from tax, you are...

  • Q

    Please suggest a good money back policy for me. I am 27 years old and want to accumulate Rs 10lakh over 10 years.

    A

    If you are a fan of traditional money back policies, go in for the LIC New Money Back Policy of 20 or 25 years. I would suggest you go in fo...

  • Q

    I want to buy a life insurance for my brother Please suggest a good policy. He is 19 years old. he should get Rs 5 lakh when he turns 25 years.

    A

    Best to go in for a ULIP in case he is looking to grow the money also. Go in for a ULIP like HDFC Click 2 Invest which is very low on charge...

  • Q

    In 2013, I bought an Endowment policy from LIC. Premium for that is around 35K per year. Now i understand, this was a big mistake and i want to go for a term insurance policy. I have already paid two premiums in 2013 and 2014 and I want to make this policy paid-up. Can i pay one more premium this year and make that endowment policy paid-up ? Or is there any better alternative ? Please suggest.

    A

    Yes, you can convert to a paid-up policy after 3 years premiums have been paid. I would recommend that you surrender the plan and take back ...

  • Q

    Is zero depreciation cover a good option under auto insurance? I have plans to buy honda city in January

    A

    Zero depreciation is a good option to along with the standard car insurance plan. By paying a slightly increased premium you can ensure that...

  • Q

    I am 20 years old,I am getting 17+ % or returns from share in my portfolio consistently for the last 6 months.should i think about a career in stockbroking?

    A

    Its nice to note that your portfolio has been gaining such high returns, however it might be too early to take a call and make stockbroking ...

Explore Moneycontrol

Copyright © e-Eighteen.com Ltd. All rights reserved. Reproduction of news articles, photos, videos or any other content in whole or in part in any form or medium without express written permission of moneycontrol.com is prohibited.