question about bonds??

Question

I have owned bonds before, and always held them to maturity, there is one part about bonds though where I always struggle with.
say for instance when a bond is issued yielding 5%, and interest rates go to 6%, does the bond price go higher or lower, I know this is a silly question, but somehow my brain does not get this.

Answer 1

Bond prices move in the opposite direction of yield rate. This is only something you need to worry about if you plan to sell the bond before it matures.

First there are two types of bonds. Government bonds are purchased at a par price. A double E bond sells for $50 and at maturity it is worth $100. If you redeem it in between you get somewhere between $50 and $100.

Corporate bonds are generally bought at face value and the owner receives payments until maturity and it is then redeemed for face value. These are the ones you buy & sell or "trade".

Let's say the going yield today is 5% and company XYZ issues bonds at $1000 face value and you buy one. For a year you collect interest payments of $4.17 a month (5%/12X$1000). Then you want to sell.

If the current interest rate is up to 7% a bond buyer can either buy your bond, paying $4.17 a month (and will only pay for 9 years), or a new bond that pays $5.83 a month for 10 years.

Obviously you would need to offer the buyer a discount for your bond. If interest rates go down the opposite is true.

Just remember opposite direction, interest to price. It does get much more complicated when you figure in bond rating and other factors.

Answer 2

Bond prices move inversely to interest rates...as rates go up prices go down. This is because if one were to purchase your 5% yielding bond they would be losing 1% by not getting the market rate of 6%. Therefore; to make a lower yielding bond a good buy it must sell at a discount. The capital gain received by purchasing the bond at a discount will even out the 1% lost on the lower interest payment.

Answer 3

An inverse relationship so the bond price goes down when the rate goes up.

Think of it this way, your bond pays 5% and I could buy it or one that pays 6% why would I buy yours? Because you lowered your price so my yield is 6%. Flip side is if you had a bond in the early 80s that paid 10% and rates fell to 5% wouldn't you love to have that old rate? Would you sell it for face value or ask more money to the person getting that great rate?

Answer 4

I like Tina Turner - Goldeneye Chris Cornell - You Know My Name Madonna - Die Another Day Who did Goldfinger? That song was good. Best one, uh, uh, (man this is tough I really love Madonna but it wasn't that great a song), I pick Chris Cornell. BA: Dr. No Hey what was the song in the new one? Oh I forgot Duran Duran - A View To Kill, that song also rocks. I just realized I have only seen the Sean Connery and Pierce Brosnan James Bond flicks. So I don't really know, I mean the song from Moonraker might kickass.

Answer 5

As long as the bond's issuer remains stable, the bond gives the investor a guarantee that the issuer will make the interest (or coupon) payments at certain intervals and will then pay back the original sum of money lent (the principal) at a specified date (the maturity date). It is because of this that most investors assume high-quality bonds have no risk.

The problem occurs if you wish to sell your bond before it matures, on the secondary market. If interest rates have risen since you bought your bond, newly issued bonds will be sold with higher coupon payments than what your bond pays. As a result, no other investor will buy your bond at the par price. Why would they? They can, instead, purchase a newly issued bond at par price, but one that pays higher interest. So, in order to make your bond competitive, you would have to sell it at a discount. The discount necessary would be the price at which your old bond yields the same interest to the new investor as the newly issued bonds would. Remember that bonds are only issued and redeemed at par. What happens in between is based on free market forces.

Let me illustrate with an example. Let's say that you bought a 10-year Treasury bond on the day of its issue, at $1000 par. It was issued with a 5% coupon rate, meaning that it pays $50 per year in interest. A year later, you want to buy an Xbox 360. So you decide to sell your bond on the secondary market to get your money back. But the Fed has raised interest rates. Now, 10-year Treasury bonds are being issued with a 7% coupon rate. These new bonds are sold at $1000 par and pay $70 per year in interest. You cannot simply sell your bond at its par price of $1000 because no rational person would buy it from you at that price. They would buy the new bonds instead. In order to sell your bond, you would have to lower its price to around $714. Your bond still pays $50 per year in interest, as is stipulated in the bond's contract. But now, the new owner buys it for $714 and receives $50 per year in interest, which calculates to a 7% interest rate (50 divided by 714 = 0.07), the same as newly-issued Treasuries. (In actuality, the change in price is more complicated that this. I oversimplified to help you understand the basics.)

The actual coupon payment has not changed. Rather, the ratio of that coupon payment to the price has changed. In a secondary market where people can choose to sell their bonds before maturity, prices of outstanding bonds will fluctuate based on prevailing interest rates. This is because current interest rates influence newly-issued bond coupon rates, which compete with outstanding bonds. The outstanding bonds still pay the same coupons and are redeemed at the same par amount on the maturity date, but their selling prices will fluctuate while outstanding.

Answer 6

yes the bond price changes in the market as per the rise/fall in interest rates.