There are two key concepts that can influence returns for bond investors.

The first is carry. This refers to the running interest income or accrued interest on the bond, and the second is roll down, often referred to simply as the role.

This reflects the change in a bond's price as it approaches maturity and the applicable yield changes.

Let's take a closer look at both components.

Starting with carry. Carry is the steady stream of income or accrued interest that a bond generates.

For example, if an investor buys a US Treasury bond with a 5% coupon, they will earn interest equivalent to 5% per annum accruing daily.

For many investors, however, net carry is the more relevant metric.

This applies when the investor needs to fund the bond position such as through a repo transaction.

Consider an investor who purchases the 5% treasury bond, but finances the position through the money market at a 4% repo rate.

Ignoring complexities like haircuts and initial margins.

The gross carry of the position is 5%.

However, the net carry is only 1% because while the investor earns 5% interest on the bond, they also pay 4% for funding.

It's important to note that this calculation assumes the bond is purchased at a dirty price of 100%.

If the bond is bought above or below par, the financing rates will apply to the actual amount financed, not just the bond's notional value.

This means the net carry will differ if the bond is purchased at a premium or discounts.

Now, let's look at the second key components. The role.

This concept refers to how a bond's price tends to increase as it gets closer to maturity, assuming the yield curve remains unchanged in a normal upward sloping yield curve.

The reason for this is that as the bond moves down the yield curve IE towards shorter maturities towards that left, it rolls down to lower yields, which due to the inverse price yield relationship leads to price gains the roll, and consequently, the price gains will be higher when the yield curve is relatively steep and lower when the yield curve is relatively flat.

And what happens if the yield curve is inverted in an inverted yield curve where short-term yields are higher than long-term yields, rolldown might not generate price gains, but instead price declines.

This is because as the bond moves towards short maturities, it encounters higher yields rather than low ones, potentially decreasing the bond's price.

However, it's important to remember that rolldown is not guaranteed income or expense.

More often than not, the yields curve changes over time, and these changes impact how the bonds price changes.

Also, as the bond gets very close to maturity, the pull to par effect takes over.

This means the bonds price will gradually converge towards its face value, usually a hundred percent, even if yields remain the same.

For example, after four and a half years, a five year bond will have only six months left until maturity.

And no matter how favorable the rolldown looks, the clean price usually won't be much above par.

This is because the bond is fast approaching its redemption dates when the par value will be paid as an actual cashflow to investors, and this cashflow becomes the most important influencer of price.