Polls / May 26, 2010

If interest rates rise, do bond prices?

When interest rates rise, bond prices typically fall. Sixty-four percent of respondents to the latest eZonomics online survey got the answer to this investment question right.

Take an interest in bonds - they can be useful investments
Bonds can be a useful investment tool. An eZonomics video explains how bonds work and how they can play a part in an investment portfolio, while the United Kingdom's Money Advice Service website gives a detailed definition of bonds that covers the risk profile and how bonds are bought and sold.

When interest rates rise, bond prices fall. Tell me why.
A bond is essentially a loan. As we know through our own loans (such as a mortgage or a bank loan), borrowing is heavily linked with interest rates.
In the case of bonds, the interest the bond holder earns is set at a point in time. If interest rates rise, bonds issued after the rise will have a higher interest rate - and, therefore, make earlier bonds less attractive to buyers if the bond holder tries to sell. The bond price falls to reflect this.
On the other hand, falling interest rates see bond prices rise. This happens because investors who bought early will have locked in a higher interest rate. An investor wishing to sell their bond before it matures would be able to ask a higher price to reflect this.
Economics website Pop Economics gives more examples of the dynamic in current market conditions.

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eZonomics team
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