The see-saw
Suppose you own a 10-year bond that pays 4% on 1,000 dollars. A year later, new bonds of the same quality pay 5%. Nobody will pay full price for your 4% bond when they can buy a 5% one, so its market price drops until its yield is competitive.
A worked example (made-up numbers)
Take a 10-year bond with a 4% coupon, face value 1,000 dollars, paid twice a year. If market yields for similar bonds rise to 5%, the bond is worth roughly 922 dollars. If yields fall to 3%, it is worth roughly 1,086 dollars. The coupon did not change; the price did.
Duration: how sensitive is it?
Duration, measured in years, estimates how much a bond’s price moves for a 1 percentage point change in yields. A bond fund with a duration of 6 would be expected to fall about 6% if yields rose one point, and rise about 6% if they fell one point. Longer maturity and lower coupons mean longer duration.
Why this matters to you
- Short-term bond funds move less than long-term bond funds.
- When the Federal Reserve raises rates, bond prices often fall at first, then yields on new bonds are higher.
- If you need the money soon, a short-term bond or Treasury bill limits this risk.
What about stocks?
Rates also influence stocks. See how interest rates affect stocks.
Quick answers
Is it a good time to buy bonds when rates are high?
Higher starting yields mean more income and a larger cushion against price drops, but nobody can time rates reliably. Match maturities to when you need the money.