Fixed Income: Perception is Reality
Reference is Handbook of Fixed Income Securities by Fabozzi.
When we look at bonds we look at yields to maturity to find out what return we would get if we held the bond to maturity given the price we have to pay to purchase the bond. There is a yield curve of differing returns to differing tenors of bonds. It seems logical that longer term bonds may be more illiquid because you have to tie up your money for longer and there is a risk premium for that so the yield curve is upward sloping or tends to be. The critical factor with fixed income trading is that perception makes reality as the interest rates themselves are determined by supply and demand for treasury bonds and whichever type of bond you are looking at. If perception moved in a way that your bonds get overvalued then your interest rate will fall and you will attribute your long bond profits to a fall in interest rates but really it was supply and demand and perception that moved the price. This differs from the stock market where earnings each quarter sends strong signals about the success or failure of a stock. Generally bonds are far from default risk unless they are junk bonds and the price moves on interest rates which has mathematics behind it in that you can imply forward rates for example but it is rather the layers of perception at each time tenor that work together to imply an overall dream which is the yield curve.