DEFINITION of 'Back Up'
A back up is a slang term for the movement in spread, price or yield of a security, which makes it more expensive to issue. A back up is characterized by an increase in bond yields and a decrease in price. The price of a security "backs up" when a company finds the security more costly to issue when raising funds.
BREAKING DOWN 'Back Up'
When a backup occurs, the fund-raising efforts of a company are diminished. For example, if interest rates increase, the required yields on most bonds rise as well. This forces a company to raise the coupon on its bond issue, which increases the interest payment, or sell the bonds at a discount, reducing the level of incoming cash.
Within the bond market, a backup occurs when yields rise and prices fall. The yield references the return paid on a stock and is generally expressed as an interest rate paid on the bond or stock. This brings in a situation where the return rate increases, leading to higher amounts paid out in dividends, but the price of the bond itself lowers.
Additional Definitions of Back Up Within Finance
A back up can also represent the action of selling one bond, generally with a longer maturity, and using those proceeds to purchase a different bond, often with a shorter maturity. This method is most commonly used in situations where short-term interest rates are more favorable than the longer-term rate. In these instances, the newly acquired bond results in more favorable yields than the one that was traded.
Another use of the term back up applies when the market experiences a short-term trend relating to the direction of the market. For example, if the market is seen to be gaining overall, but then experiences a brief downward trend, that downward trend may be referred to as a backup. The term can also be used when describing the reverse.
Interest Rates in the Bond Market
Although the bond market is generally seen as a safer investment when compared to some other options, it carries the same risks as others. The factor with the highest impact on the price of a bond is interest rates. As interest rates rise, prices on existing bonds fall. This is because the existing bonds have lower interest rates. This makes them less valuable on the bond market than newer bonds issued at the current, higher interest rate.