Why Bond Prices Go Up and Down
Step 1: How Do Changing Interest Rates Affect My Bonds?
Bond prices go up and down in response to two factors: changes in interest rates and changes in credit quality. Individual investors who purchase bonds tend to worry a lot about the safety of their money. Generally, however, they tie safety to credit considerations. Many individual investors do not fully understand how changes in interest rates affect price. Since the late 1970s, changes in the interest rate environment have become the greatest single determinant of bond return. Managing interest rate risk has become the most critical variable in the management of bond portfolios. In this article, we'll see why.
Interest Rate Risk
"Interest rate risk," also known as "market risk," refers to the propensity bonds have of fluctuating in price as a result of changes in interest rates.
All bonds are subject to interest rate risk.
If nothing else makes an impression, but you learn that all bonds are subject to interest rate risk, regardless of the issuer or the credit rating or whether the bond is "insured" or "guaranteed," then this article will have served a useful purpose.
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