What Is a Bull Bond?

A bull bond is a debt instrument with a price that is expected to increase in value if interest rates decline and the stock market performs well.

Key Takeaways

  • A bull bond is a debt instrument with a price that is expected to increase in value if interest rates decline and the stock market performs well.
  • The most common type of bull bond is the principal-only strips (PO) mortgage-backed security.
  • Bull bonds can diversify an investor's portfolio in a bull market.

Understanding Bull Bonds

There is an inverse relationship between bond prices and their yield, which is tied to market interest rates. As a result, most bond prices tend to increase when interest rates decline. In a bull market, there are greater capital inflows into stocks that occur at the expense of fixed-income instruments. This is because investors see a greater likelihood of generating superior returns in the stock markets. The lack of demand for bonds, usually, depresses their prices.

What Is a Bull Market?

A bull market is a financial market marked by optimism and investor confidence. The term bull market–associated with trading in the stock market–can also apply to anything traded, such as bonds, currencies, and commodities.

Because psychological effects and speculation sometimes play a significant role in the markets, market trends are difficult to predict and bull markets are typically only recognized once they’ve happened. One commonly accepted definition of a bull market is when stock prices rise by 20 percent after a drop of 20 percent and before a 20 percent decline. The average bull market lasts nine years. It is the opposite, a bear market, which lasts for an average of 1.4 years.

A strong or strengthening economy, low unemployment, and a rise in corporate profits are characteristics of a bull market. In a bull market, investors are more willing to take part in the stock market to gain profits. Investors who want to benefit from a bull market should buy stocks early to take advantage of rising prices and sell those stocks once when they’ve reached their peak.

How a Bull Bond Works

A bull bond is a specific type of bond that outperforms other bonds that do well in a bull market. The most common type of bull bond is the principal-only strips (POS) mortgage-backed security. Whereas most bonds increase in value in a declining rate market, mortgage-backed securities perform exceptionally well. Bull bonds can diversify an investor's portfolio in a bull market.

A principal-only strip (POS) mortgage-backed security is a fixed-income security, where the holder receives the non-interest portion of the monthly payments on the underlying loan pool of mortgage securities. POS mortgage securities do well in a declining-rate market because mortgage holders refinance their loans at lower interest rates. Investors are then repaid their original investment more quickly, increasing the rate of return for the mortgage-backed security.

Though many bull bonds tend to be mortgage-backed bonds, there are other kinds of bonds that perform well during a bull market and could also be considered bull bonds. The general bond market can be classified into corporate bonds, government and agency bonds, municipal bonds, asset-backed bonds, and collateralized debt obligations (CDO), in addition to mortgage bonds.