Bonds have an inverse relationship to interest rates. When interest rates r💜ise, bond prices usually fall, and vice-vers🔯a.

To those unfamiliar with 澳洲幸运5开奖号码历史查询:bond trading, the negative correlation between 澳洲幸运5开奖号码历史查询:interest rates and bond prices may be counterintuitive. But it makes sense when you consider that a change in interest rates, up or down, makes bonds that were previously issued more or less lucrative to investors in com🎐parison with new bonds issued after the change.

Bond Prices vs. Yield

Bond investors, like all investors, try to get the 澳洲幸运5开奖号码历史查询:best return possible. To achieve this goal, they need to keep tabs on the fluctuating costs of borrowing. When looking at bonds, there🦄 are two key things to consider.

The bond's price is the amount that you need to pay to purchase the bond. If you're buying it directly from the bond issuer, you'll typically pay the same as its face value. If you're buying it from another investor, the price may be higher or lower.

The 澳洲幸运5开奖号码历史查询:bond's yield is the ret༺urn you receive in the form of interest. The current yield of a bond is determined by dividing its annual interest payment by its current price.

When a bond's price falls, its yield rises because the annual interest payment remains the same. Similarly, when the price rises, its yield falls because you're dividing the interest payment by a larger number.

An easy way to grasp why bond prices move in the opposite direction of interest rates is to consider 澳洲幸运5开奖号码历史查询:zero-coupon bonds, which don't pay regular interest and instead derive all of their value from the difference between the purchase price and the 澳洲幸运5开奖号码历史查询:par value paid at maturity.

Zero-coupon bonds are issued 澳洲幸运5开奖号码历史查询:at a discount to par value, with their yields a function of the purchase price, the par value, and the time remaining until maturity. Zero-coupon bonds also lock in the bond’s yield, which is attractive to some investors.

Zero-Coupon Bonds

If a zero-coupon bond is trading at $950 and has a par value of $1,000 (paid at maturity in one year), the bond's rate of return will be 5.26%: (1,000 - 950) ÷ 950 x 100 = 5.26. In other words, an investor can pay $950 for this bond and get the money back plus a 5.26% return a year down the road.

Is that a good deal? It depends on what happens in the 澳洲幸运5开奖号码历史查询:bond market during that year. If current interest rates were to rise, newly issued bonds might offer a yield of 10%. The zero-coupon bond🐭 yielding 5.26% has become much less ✱attractive in the bond market.

To attract demand in the bond market, the price of the pre-existing zero-coupon bond would have to decrease enough to match the return yielded by prevailing interest rates. In this instance, the bond's price would drop from $950 (which gives a 5.26% yield) to approximately $909.09 (which gives a 10% yield).

That is how a bond's price moves relative to interest rate changes.

When interest rates drop

Of course, interest rates might 𝕴also drop during the year be🐠fore that bond matures.

If they dropped to 3%, the zero-coupon bond, with its yield of 5.26%, would suddenly look very attractive. More people would buy the bond, which would push the price up until its yield m⛎atched the prevailing 3% rate. In this instance, the p🌄rice of the bond would increase from $950 to about $970.87.

Given this price increase, you can see why investors 澳洲幸运5开奖号码历史查询:selling their bonds benefit from a decrease in prevailing interest rates. These examples also show how a bond's 澳洲幸运5开奖号码历史查询:coupon rate and, consequently, its 澳洲幸运5开奖号码历史查询:market price are directly affected by interest rates.

To attract investors, issuers of new bonds tend to offer coupon rates that match or exceed the current national interest rate.

Zero-coupon bond details

Zero-coupon bonds 澳洲幸运5开奖号码历史查询:tend to be more volatile as they do not pay periodic interest during the life of the bond. Upon maturity, a zero-coupon bondholder receives the 澳洲幸运5开奖号码历史查询:face value of the bond. Thus, the value of these bonds increases the closer they get to expiring.

Zero-coupon bonds also have unique tax implications. Even though no periodic interest payment is made on a zero-coupon bond, the annual accumulated return is considered to be income and is taxed as interest income.

The bond is assumed to gain value as it approaches maturity, but this gain in value is not viewed as 澳洲幸运5开奖号码历史查询:capital gains, but rather as income.

That means taxes must be paid on these bonds annually, even though the investor does not receive any money until the bond maturity date.

Bond Prices and the Fed

When people refer to "the national interest rate" or "the Fed rate," they're usually referring to the 澳洲幸运5开奖号码历史查询:federal funds rate set by the Federal Open Market Committee (FOMC). This is the rate of interest charged for the interbank transfer of money held by the Federal Reserve. It is used as a benchmark for interest rates on all kinds of investments and debt securities.

Fed policy initiatives have a 澳洲幸运5开奖号码历史查询:huge effect on the prices and the yields of bonds. When 💃the Fed increases the federal funds rate, the price of existing fixed-rate bonds decreases and the yields on new fixed-rate bonds ඣincrease.

The opposite happens when interest rates go down; existing fixed-rate 澳洲幸运5开奖号码历史查询:bond prices go up and new fixed-rate bond yields decline.

The Bottom Line

Interest rates and bond prices have an inverse relationship. When interest rates go up, the prices of bonds go down, and when interestဣ rates go down, the prices of bonds go up.

This happens because new bonds are issued with a higher yield, making existing bonds less attractive because they carry less interest. The prices on these lower-rate bonds must be reduced to make them attractive to buyers.