Bond Pricing
The math that moves trillions - and how to use it.
The Day Treasuries Broke
March 12, 2020. The Treasury market - the deepest, most liquid market on Earth - seized up. Prices disconnected from yields. Dealers couldn't quote. The "risk-free" asset had become a source of risk.
What happened? Everyone needed cash. Simultaneously. Hedge funds facing margin calls dumped Treasuries. Foreign central banks sold. Even money market funds - supposedly the safest vehicles - were liquidating. The very structure of the market buckled under the weight of forced selling.
The Fed responded with unprecedented force: unlimited QE, direct Treasury purchases, emergency lending facilities. Within weeks, order was restored. But those chaotic days revealed a fundamental truth: bond prices are just math - until they're not. In a crisis, liquidity trumps valuation.
Understanding bond pricing isn't just academic. It's knowing when to step in during a panic - and when to step aside when the math says "buy" but the market says "run."
Why Bond Pricing Matters for Traders
Every rates trade starts with one question: what's the fair price? Whether you're positioning for a Fed decision, building a carry portfolio, or hedging corporate debt - you need to know what a bond is worth.
Entry Point Decisions
When 10Y yields hit 5% in October 2023, was it time to buy? Bond math told you that each 1% yield drop would generate 8% price gains. But you needed to believe the Fed was close to done hiking.
Risk Management
A $100M bond portfolio at current yields has roughly $7.5M at risk for every 1% rate move. Do you know your exposure? Can you afford to be wrong?
Relative Value
Is a 5% coupon bond at 102 rich or cheap versus a 3% coupon bond at 95? Without understanding pricing mechanics, you can't spot mispricings.
Historical Examples
Learn from market history. Select a pivotal moment to see how bond prices behaved - and what happened to traders caught on the wrong side:
Flight to Quality
+14%The Setup
Lehman Brothers collapsed. Credit markets froze. Investors stampeded into Treasuries.
What Happened Next
10Y yields crashed from 3.8% to 2.1% in weeks. A $10M long position made +$1.4M. This was "buy the fear" at its finest.
The Price-Yield Relationship
This is the most important chart in fixed income. Bond prices and yields move in opposite directions. The relationship is not linear - it's convex. This asymmetry is your edge.
Why Convexity Matters
Notice the curve shape: a 1% yield drop boosts price more than a 1% yield rise hurts it. This asymmetry means being long bonds has a built-in advantage - you make more when you're right than you lose when you're wrong (all else equal).
Real example: In October 2023, buying 10Y at 5% yield meant: if yields fell 100bps, you'd gain ~8.5%. If yields rose 100bps, you'd lose ~7.5%. The payoff was asymmetric in your favor.
Buying the Dip vs Catching a Falling Knife
The hardest question in bond trading: when is a selloff an opportunity, and when is it the start of something worse? Here's how professionals think about it:
Signs of Opportunity
- Forced selling: Margin calls, fund redemptions, month-end rebalancing
- Liquidity vacuum: Yields moving without fundamental news
- Extreme positioning: Everyone short, CTAs fully bearish
- Carry turns attractive: Yields significantly above financing cost
- Technical exhaustion: RSI oversold, failed breakout attempts
Example: October 2023. 5% 10Y yields meant 150bps positive carry. Positioning was max short. Yields reversed 80bps in a month.
Signs of a Falling Knife
- Regime change: Fed pivoting hawkish, inflation surprising upward
- Fundamental repricing: Term premium expanding, deficit concerns
- New sellers emerging: Foreign central banks, pension funds
- Negative carry: You're paying to hold the position
- Catch-up moves: Yields playing catch-up to other assets
Example: 2022. Each dip-buy was punished. Inflation kept surprising. Fed kept hiking. "Value" buyers got crushed.
The Professional's Framework
Before buying a bond selloff, answer these questions:
- What's driving the move? Technical/positioning (opportunity) or fundamental (danger)
- What's my carry? Positive carry buys time; negative carry bleeds
- What's positioning? Crowded shorts = opportunity; crowded longs still unwinding = danger
- What's my horizon? Short-term trades need catalysts; long-term can ride volatility
Build Your Bond Position
Trade Legs
No legs added. Click "Add Leg" or select a preset strategy above.
Clean vs Dirty Price: What You Actually Pay
When you see a bond quoted at 98.50, that's the clean price. But when you wire money to settle, you pay the dirty price - clean plus accrued interest since the last coupon.
Why this matters: On a $100M position, the accrued interest can be $500K-$2M depending on where you are in the coupon cycle. That's real cash flow you need to fund.
Settlement Example ($10.0M Position)
Trade Examples (Simple)
Three real-world scenarios explained like you're five (but with actual numbers):
Example 1: Buying the Dip
October 2023 - 10Y yield hits 5% for first time since 2007. You buy $10M at 5% yield (price ~92)
You don't put up $10M cash. You finance via repo: post $500K margin (5%) and borrow $9.5M at 5.3% repo rate. Your actual cash at risk is $500K, but you control $10M of bonds. This is 20x leverage - a 5% adverse move would wipe out your equity.
Yields fall to 4% by end of year as inflation cools
Duration ~8 years x 1% yield drop = 8% price gain. $10M x 8% = +$800K
You bought when everyone was panicking about high rates. Rates fell. You made $800K in 2 months. On $500K of your own capital, that's a 160% return - leverage amplified your gains.
Example 2: Catching a Falling Knife
Early 2022 - You buy $10M of 10Y at 2% yield thinking it's a good entry
You post $500K margin (5%) and borrow $9.5M via repo at 0.5%. At first, your carry is positive (2% yield minus 0.5% funding = 1.5% net). But as the Fed hikes, your repo cost rises to 4%+ while your bonds bleed value. Leverage cuts both ways.
Inflation explodes. Yields rise from 2% to 4.5% by year end
Duration ~9 years x 2.5% yield rise = 22.5% loss. $10M x -22.5% = -$2.25M
You tried to buy the dip but the dip kept dipping. You lost $2.25M on a $500K investment - your equity was wiped out 4x over. Plus you faced margin calls as prices fell. Leverage amplified your losses.
Example 3: Premium vs Discount
You compare two 10Y bonds, both yielding 4.5%. Bond A has 6% coupon (price 112), Bond B has 3% coupon (price 88)
To go long: Finance via repo as above. To go short: Borrow bonds via reverse repo or securities lending. You sell the borrowed bonds, receive cash, and invest that cash at the repo rate. When you close, you buy bonds back and return them. You profit if the price fell, lose if it rose.
You hold for 1 year, rates unchanged
Bond A "pulls to par" losing $1.2 in price but pays $6 coupon. Bond B gains $1.2 pulling to par plus $3 coupon. Both return 4.5%
High coupon bonds cost more but pay more. Low coupon bonds cost less but appreciate more. At same yield, total return is identical. But if you're shorting, you owe the coupon payments - shorting high-coupon bonds costs more to carry.