What Happens to the Yield on a Bond When Its Price Rises?
One-Year Dollars Nicholas Dunbar, a financial journalist educated as a physicist at both Cambridge and Harvard Universities, explains this point at some length in his book on the Long-Term Capital Management meltdown, “Inventing Money.” Dunbar asks you to imagine that all bonds pay off at maturity in denominations of $1. There is, then, a “10-year dollar” and a “one-year dollar.” The yield is easy to calculate. If you buy a one-year dollar for $0.91 at issuance and hold it to maturity, you get $0.09 for your patience, or a yield of 10 percent. A Crisis Dunbar asks you to imagine that there is then a crisis somewhere outside of the U.S. You have by this time bought a lot of those $1 bonds. Due to the crisis, investors who want to keep their money safe decide to buy U.S. bonds. They know you have some, so they call you. You find that you can charge $0.95 for them. Anyone who buys one of those bonds and holds it to maturity will make only 5 percent. The price has risen, so the yield has f
