Bond Prices and Bonds-Interest Rates Relationship
Bonds represent a good investment tool for investors that are not comfortable with risk. However, bonds have an element of the volatility of stocks and are also influenced by the changes occurring in the economy. As a result the bond's value may be decreased.
The factor that influences the value of bonds to the highest degree is rising interest rates. The prices of bonds are inversely linked to the levels of interest rates. This means that an increase in interest rates leads to a decrease in bond prices. Of course, this is true only for bonds that have already been issued and are now traded in the open market.
For instance, if you want to sell a bond that has a lower interest rate level than the one that is currently experienced you should decrease the face value of the bond. However, if the opposite conditions are experienced (i.e. the bond's interest rate is higher than the current levels on the open market), thanks to the higher fixed interest rate you will be able to sell the bond at a premium that is greater than the face value.
However, if you are patient enough and wait for your bond to mature, no matter what the interest rates are, at maturity time you will get the face value you have agreed upon when you purchased the bond. In other words, interest rates matter only when the investor plans to trade the purchased bonds.
Some investors use bonds for trading purposes. In such cases they should pay special attention to the levels of interest rates since they play an important role in the determination of the value of bonds. Additionally, they should be aware that bonds with longer terms experience higher degree of interest rate risk than those of shorter terms.
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