Bonds And Interest Rates

Bonds and interest rates have a complimentary relationship of sorts. In the initial stages the relation to a great extent will seem illogical of sorts, but if one gets into the details it makes sense of sorts for sure. One of the easy tools to grasp the fact on why interest rates and bonds move in opposite directions is to consider zero discount coupons where one does not pay for the coupons but considers the difference between the purchase price and the paid up value.

bonds- interest- rates- key-to-understanding-bonds

An example will illustrate the concept of bond and interest rates in a better way. If a person pays say $ 950 for a bond he might be more than happy to receive 5.26 % return on his investment for sure. But it needs to be kept in mind that the level of satisfaction depends on what else is happening in the bond market. if interest rates are rising and providing 10 %  interest then who would be satisfied with a 5.26 % rate of return. In fact to attract the demand the price of the bond would have to be fine tuned with the interest rates which are being offered in the market. This clearly explains the relationship between bonds and interest rates.

If one tries to establish the relationship between bonds and interest rates, they need to understand the fluctuations of the bond prices. Just like any public traded security the prices of bonds keep changing on a daily basis for sure. One need not keep the bond till the time of maturity as they can sell the bond anytime in the market when the price fluctuates. In addition there is the option of keeping the bonds till they yield on maturity. This is the scenario where the full value is received on maturity. It tends to include all the interest payments as well as gain or loss if the bonds are purchased at a premium. Understanding the calculation of it is cumbersome, but the key point of observation is they are more accurate and helps in better comparison.


As far as bond and interest rates are concerned the relationship of price and yield have a definite bearing on it. If the price increases the yield tend to decrease and vice versa. If one depicts in technical terms both of them are inversely related. It needs to be kept in mind that yield, maturity and returns have a total bearing on the price of the bond. The most important factor influencing the price of a bond is the interest rates which are prevalent in the economy. When interest rates rises, the prices of the bonds falls bringing it at par with the old bonds and it is the other way around when the interest rates falls. So one has to exercise caution with aggression in choosing the bonds .

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