Bond Yields and Interest Rates: Explain it like I’m 5.

There’s a lot of news surrounding some regional banks in the US failing lately, which has brought up the topic of Bond Yields and how their recent performance may influence the BOC to lower interest rates sooner than previously expected.

This is a terribly dry topic, but it is an important one to understand. So my friend recently asked me to explain it as if he was 5 years old, and this is what I came up with:

Imagine your friend has a lemonade stand and they want to borrow money from you to buy more lemons. They offer to pay you back in full when they get their next allowance, plus a little extra money. That extra money is like a little thank you gift, and the grown-ups would call that interest (and also Bond Yields).

Now there’s a group of grown-ups that make decisions for the country, and build cool things for everyone including hospitals and schools. Now sometimes they’ll need extra money to get things done faster, so they’ll ask the other grown-ups to lend them money by selling them a Bond.

What is a bond? What are Bond Yields?

A bond is a piece of paper, kind of like an IOU note. The grown-ups hold on to that piece of paper for a while and then the government will pay them back, with some extra money on top; the thank you gift 🙂

Now sometimes if there are a lot of grown-ups that want to help and buy these pieces of paper, the thank you gifts will be smaller. If the government is in a tight spot and needs more grown-ups to buy, they’ll need to make the thank you gift bigger to try and convince them it’s a good deal. So when the thank you gifts are big, that means that it’s costing the government more money to borrow money from the grown-ups, and when they are small that means it costs the government less money.

When it comes to the government thank you gifts, most adults refer to them as Bond Yields.

Where do grown-ups borrow money?

There are bigger piggy banks out there that take up whole buildings, and they are just called “Banks”, and they hold grown-ups’ money for safe keeping, as well as some extra money for lending. Sometimes grown-ups want to buy a big toy but they don’t have enough money in their bigger piggy bank, so they have to ask the grown-ups that work at the Bank if they can borrow some of that extra lending money.

The grown-ups at the Bank will gladly lend the money, but they would need a thank you gift paid to them when it’s time to pay the money back. They will look at the size of the thank you gifts that the Government is giving out when they borrow money, and in turn use that to decide how much to ask for.

The bank grown-ups will look at how big their thank you gift would be if they took the money that they were going to lend out and gave it to the government, and then asks for a slightly bigger thank you gift from grown-ups who want to borrow money. If they didn’t ask for a slightly bigger gift from other grown-ups, then they would be better off just buying that piece of paper from the government instead of other grown-ups.

They use the thank you gifts they receive from the grown-ups to keep the pile of extra money at a big size so they can lend to many other grown-ups, as well as be able to pay the grown-ups that work there.

Wrap it up, recess is almost over

So when there is a sudden drop or rise in the size of the thank you gifts given out by the government (also called bond yields by the grown-ups) this can affect the thank you gifts being asked for by the Banks shortly afterwards.

This is why grown-ups pay attention to these kinds of things because it helps them predict how much of a thank you gift they’ll need to pay the bank when they want to borrow money for a big toy.

If grown-ups already have received a loan from the bank but the thank you gift (aka interest rates) have been lowered they might want to talk to the grown-ups at the bank to see if there’s anything they can do about changing their agreement about the thank you gift they owe.

To the Grown-ups

If you have any questions about your current Mortgage, or what happens when you get pre-approved and then the thank you gif – i mean interest rates – change, send me a quick message and I’ll get you in touch with a trusted mortgage advisor.