However, the individual has the choice, rather than holding onto the bond for 10 years, of selling the bond. He can do this on the bond market. However, the price he will get for the bond will not always be the same as the price he paid for it. Lets take Ireland as an example. There are now doubts as to whether Ireland will be able to repay its bonds. Essentially making people who own the bonds unsure as to whether they will get their money back at the end of their investment. Understandably, this makes these people concerned and makes the bonds less valuable as they may not be worth the full value. Therefore, on a bond market they may be sold for less than the initial investment, so the €100 bond may be sold for €50. Bad new makes the value of bonds fall. Good news makes the value of bonds rise.
However, someone who purchases the bond at €50 from someone who had initially paid €100 still receives the same rate of interest. So as the interest was 5% on €100, even though the bond has been re-bought for €50 the new owner still gets the benefit of the 5% interest on the initial €100 investment. This is where bond yields come in. Effectively, the yield, or return, on the bond is now 10%. This is because the individual is receiving €5 a year (5% of €100) for a €50 investment (essentially yielding 10%). Therefore, as Irish bonds would yield a return of 10% on the market when the Irish government reissues more bonds, in order to make them attractive to investors, they must sell them with an interest rate close to the yield on the market.
This process has resulted in the developments which have been observed in the Irish bond market. Initially, yields on Irish bonds were low because during the Celtic Tiger and construction bubble there was little doubt in peoples minds about Ireland’s ability to repay its debts. However, as the economy declined and the government failed to control its budget balances, this resulted in investors getting nervous about the ability of the government to pay them back. This developed over time until Irish bond yields climbed to over 8% towards the end of 2010. As the amount we had to pay increased. Investors thought it increasingly unlikely that we would be able to repay our debts and the crisis became a self reinforcing problem. This continued until Ireland was bailed out by the EU and IMF, effectively providing us with sufficient funds so that we would not have to go to the bond markets for funds and providing their funds at a much lower rate than the market was demanding.