What is the relationship between interest rates and bonds? It’s an inverse relationship. In this post, we’re talking about what this means for investments. In a previous post, we talked about bonds and what they are, and today we’re covering how they are affected by interest rates.
That means that when interest rates rise, the value of existing bonds tends to decline, and when interest rates fall, the value of existing bonds tends to rise.
This is because the market value of a bond is based, in part, on the interest rate that investors can earn on new bonds.
When interest rates rise, new bonds become more attractive to investors, and the value of existing bonds tends to decline.
Conversely, when interest rates fall, new bonds become less attractive to investors, and the value of existing bonds tends to rise.
For example, let’s say you own a bond that pays a fixed interest rate of 5%. If the interest rate on new bonds rises to 6%, the value of your bond may decline because investors can earn a higher rate of return on new bonds.
On the other hand, if the interest rate on new bonds falls to 4%, the value of your bond may increase because new bonds are less attractive to investors.
This inverse relationship between bonds and interest rates is known as the “interest rate risk” of bonds.
It’s important for investors to understand this risk and to consider it when making investment decisions.
In general, bonds with longer maturities are more sensitive to changes in interest rates and tend to be more risky than bonds with shorter maturities.
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