What is the relationship between Discount Rate and Bond?

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oem7110
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What is the relationship between Discount Rate and Bond?

Post by oem7110 » Sat Feb 20, 2010 3:45 am

Does anyone have any suggestions on what the relationship is between Discount Rate and Bond's Current Yield? When the discount rises, the Bond's Current Yield rise also, and I don't understand the direct relationship between cause and effect. Does anyone have any suggestions why Bond's Current Yield rise as discount rate rise?
Thanks in advance for any suggestions
Eric

Miles
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Post by Miles » Sat Feb 20, 2010 4:19 am

Eric,

the relationship is purely mathematical (no cause and effect).
Formula: Current Yield = Annual Interest Payment / Current Bond Price
A higher discount rate means a lower price, hence a higher Current Yield.

oem7110
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Post by oem7110 » Sat Feb 20, 2010 9:11 am

Miles wrote: Formula: Current Yield = Annual Interest Payment / Current Bond Price
Discount rate is referred to "Federal Discount rate", which rise recently to 0.75%, not Annual Interest Payment. Current Yield rise recently to 3.77%.
Does anyone know the term period for Discount rate? Daily, Monthly, Yearly?
Bond offers 3.77% annually for interest rate.

If the Fed Interest Rate is 0.75% annually, so Bank can borrow as much as they can at this rate, then purchase U.S. Bond and the current yield is 3.77% for stable profit (3.77 - 0.75) = 3.02%. Is there any limited quote for loan at Fed Interest Rate from any Bank? If not, Bank can borrow all what U.S. gov has, and purchase U.S. Bond as long as current yield is higher than Fed Interest Rate.
Does anyone have any suggestions?

Thanks in advance for any suggestions
Eric

cjo5039
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Post by cjo5039 » Mon Feb 22, 2010 11:08 am

Eric,
Discount Rate and "Bond" are two different things. When you say "bond," I'm assuming that you are referring to the U.S. 10 Yr Bond. The Discount Rate is a short-term rate set by the Fed. Banks are able to borrow at the discount rate, but it the amount that they can borrow is limited, and the term is very short. So, you can borrow at the lower rate, but that borrowing must be constantly refinanced. The yield on the 10 Yr Bond is essentially set by the market, currently at 3.78. The yield curve is presently very "steep" - i.e. relatively inexpensive to borrow short-term, and more expensive to borrow at longer maturities.
An excellent resource for current rates can be found on the U.S. Treasury site here:
http://www.ustreas.gov/offices/domestic ... ield.shtml
A great bond "primer" is on PIMCO's website:
http://www.pimco.com/LeftNav/Bond+Basic ... Basics.htm

Hope this helps.

oem7110
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Post by oem7110 » Thu Apr 15, 2010 12:35 pm

Thank everyone very much for suggestions
Eric

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