What I want to do in this video is to give a not-too-math-y explanation of why bond prices move in the opposite direction as interest rates, so bond prices versus interest rates. To start off, I'll just start with a fairly simple bond, one that does pay a coupon, and we'll just talk a little bit about what you'd be willing to pay for that bond if interest rates moved up or down.
Let's start with a bond from some company. Let me just write this down. This could be company A. It doesn't just have to be from a company. It could be from a municipality or it could be from the U. If we just draw the diagram for this, obviously I ran out of space on the actual bond certificate, but let's draw a diagram of the payments for this bond. This is today. Let me do it in a different color. That's today.
2) Key Bond Characteristics
Let me draw a little timeline right here. This is two years in the future when the bond matures, so that is 24 months in the future. Halfway is 12 months, then this is 18 months, and this right here is six months. Now, the day that this, let's say this is today that we're talking about the bond is issued, and you look at that and you say, you know what? Now, let's say that the moment after you buy that bond, just to make things a little bit Obviously, interest rates don't move this quickly, but let's say the moment after you buy that bond, or maybe to be a little bit more realistic, let's say the very next day, interest rates go up.
If interest rates go up, let me do this in a new color. Obviously for something less risky, you would expect less interest.
Interest rates have gone up. Now, let's say you need cash and you come to me and you say, "Hey, Sal, are you willing to buy "this certificate off of me? I'll actually do the math with a simpler bond than one that pays coupons right after this, but I just want to give the intuitive sense. Or you could just essentially say that the bond would be trading at a discount to par.
Bond would trade at a discount, at a discount to par. Now, let's say the opposite happens. Let's say that interest rates go down.
Let's say that we're in a situation where interest rates, interest rates go down. So how much could you sell this bond for? I'm not being precise with the math. I really just want to give you the gist of it. Bond values fluctuate in response to the financial condition of individual issuers, changes in interest rates, and general market and economic conditions. Mutual fund investing involves risks, including the possible loss of principal, and may not be appropriate for all investors. Stock values fluctuate in response to the activities of individual companies and general market and economic conditions.
Bond values fluctuate in response to the financial condition of individual issuers, general market and economic conditions, and changes in interest rates. Changes in market conditions and government policies may lead to periods of heightened volatility in the bond market and reduced liquidity for certain bonds held by the fund.
In general, when interest rates rise, bond values fall and investors may lose principal value. Interest rate changes and their impact on the fund and its share price can be sudden and unpredictable. Funds that concentrate their investments in a single industry may face increased risk of price fluctuation over more diversified funds due to adverse developments within that industry. Foreign investments are especially volatile and can rise or fall dramatically due to differences in the political and economic conditions of the host country.
These risks are generally intensified in emerging markets. Smaller- and mid-cap stocks tend to be more volatile and less liquid than those of larger companies. High-yield securities have a greater risk of default and tend to be more volatile than higher-rated debt securities. Consult a fund's prospectus for additional information on these and other risks. This material is for general informational and educational purposes only and is NOT intended to provide investment advice or a recommendation of any kind—including a recommendation for any specific investment, strategy, or plan.
Skip to main content Log In or Register Menu attached. The entire calculation takes into account the coupon rate; current price of the bond; difference between price and face value; and time until maturity. Along with the spot rate , yield to maturity is one of the most important figures in bond valuation. If a bond is purchased at par , its yield to maturity is thus equal to its coupon rate, because the initial investment is offset entirely by repayment of the bond at maturity, leaving only the fixed coupon payments as profit.
If a bond is purchased at a discount, then the yield to maturity is always higher than the coupon rate. If it is purchased at a premium , the yield to maturity is always lower. Your Money. Personal Finance. Financial Advice.
Why Bond Prices and Yields Move in Opposite Directions
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