Let's say you had a bind with a face value of $100 and an interest rate of 10% (meaning it throws off $10 each year). Now, if the interest rate being paid on other bonds changes (interest changes based on the economy, central bank policies, whatever), in order for the bond you purchased to be marketable, the real interest rate of that bond has to change with the market - if it didn't, the interest rate would be higher (creating demand) or lower (creating excess supply) than what an investor could get on a new bond on the market. SO, let's say a new bond is issued by another company paying 9% interest, the price of your bond would increase (remember, supply and demand) on the market until the interest rate was equivalent to the new 9% - in other words, the price would increase until the $10 your bond pays in real terms is equal to 9% of the market value (there are other factors in play such as time to maturity, but this is a simple example). So, $10 is 9% of about $111.00 and the market would now price your bind at that amount - you could hold and collect the $10 annually or sell and collect $111 now for an immediate $11 per bond profit (less costs). So, when playing with millions of dollars, a 1 basis point move (1/100th of a percent) san make a big difference in value.
Can someone tell me how trader/bankers make the massive sums of money they do with bonds? Thee is a renowned trader called Lawrie Inman who managed to make over 700K in one trade with the bobl (German bonds) and said that "just the movement of one point in the market would cause him to gain or lose 10K", now I thought bonds were a fixed rate once you bought them and that you can't gain anymore than the coupon is at once you buy it or does the coupon go up depending on how many people want to buy German bonds? If someone has any info on how bonds work etc I'd be happy to hear about it, only 16 but interested in it.
Cheers.
