Close

Bond Terminology

Bond Terminology Splash image

Joseph Davis’ article explains various scenarios for interest rates. For those of you unfamiliar with some of the common terminology used to explain bonds, here is a brief primer.

Duration: A measure of how sensitive a bond is to changes in interest rates. (Bond prices are inversely related to yields. As yields rise, bond prices fall. As yields fall, bond prices rise.) Duration is calculated from the present value of all future cash flows, which include coupon payments (scheduled interest payments based on the terms stipulated in the bond) and the price at which the bond will be sold or redeemed. Duration is displayed as number of years, with lower-yielding bonds having a duration closer to the number of years until maturity than higher-yielding bonds. A higher level of duration implies a greater volatility in a bond’s price. Duration, however, is typically less than a bond’s maturity because of the flow of coupon payments. (The one exception is zero-coupon bonds, where duration equals maturity.)

Forward Rate: An estimate of bond yields at some point in the future, it is the market forecast level of what interest rates will be. The forward rate can be derived from the yield curve, using bonds of different maturities (e.g., a six-month and a one-year bond).

...To continue reading this article you must be registered with AAII.

Gain exclusive access to this article and all of the member benefits and investment education AAII offers.
JOIN TODAY for just $29.
Log in
Already registered with AAII? Login to read the rest of this article.

Register for FREE
to read this article and receive access to future AAII.com articles.
  


Discussion

Phil from Illinois posted about 1 year ago:

New investor here and excuse me for my ignorance, but if yields fall while prices rise and as yields rise bond prices fall doesn't everything 'even' out?


Charles from Illinois posted about 1 year ago:

Phil-The answer is it depends. If you hold a bond until maturity, you get back the face value (par value) of the bond. Higher future yields allow you to reinvest the proceeds into a bond with higher interest rates. If you sell a bond before it matures, you may make or lose money depending on the direction of interest rates. Bond funds don't mature, so over the short-term, you will lose money on them as yields rise. Over the long-term, you should (but are not guaranteed)to be able to make up for the loss with higher dividend payments thanks to the higher yields.

-Charles Rotblut, AAII


You need to log in as a registered AAII user before commenting.
Create an account

Log In