Bond Prices Explained
Submitted by Southwest Investment Advisors on November 18th, 2014
Bonds offer income and preservation of value on maturity. Between when a bond is issued and when the bond matures the market value of that bond will fluctuate daily. Why? Because interest rates fluctuate every day. An easy way to remember this is to think of a see-saw. When rates go up, bond prices fall. When rates go down, bond prices rise.
Think of it like this: Each day investors bring new money to the bond market for investing. Let’s say a bond issued some time ago paid 6%. And let’s assume that interest rates paid by similar bonds that are being issued today have risen to 7%. If both bonds were offered at $1,000 each, which one would you want to purchase? The 7% bond, of course, because it would pay you more income.
But what if the people who owned 6% bonds wanted to sell them? What would they have to do to persuade you to buy their bonds? They would have to lower the price of their bonds (discount it) until it became attractive to you. That’s why the prices of already issued bonds go down when interest rates go up. And when interest rates fall, bond values go up because the higher interest they pay is more valuable. Bond prices always move in the opposite direction of interest rates.
In general the bond market is volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Fixed income securities also carry inflation risk and credit and default risks.
Any fixed income security sold or redeemed prior to maturity may be subject to substantial gain or loss. The bonds are subject to availability.
Bonds are subject to interest rate, market, inflation and credit risks. Bonds that are rated by Moody’s at Ba or below are considered to have speculative elements and the repayment ability of the issuer is not assured.