Interest Rates' Impact on Bond Prices | AP Wealth Management

Interest Rates’ Impact on Bond Prices

It has been a heavy-hitting couple of weeks across the global economic landscape and most of the news articles are discussing interest rates.  Given this, AP Wealth has put together a short explanation of how interest rates impact bond prices.

The chart below shows the inverse relationship between interest rates and bond prices:

Interest Rates vs. Bond Prices

When interest rates fall, bond prices rise, and when interest rates rise, bond prices fall.

An Example

We have found the example below to be helpful in addition to the chart above:

Today, Sarah buys a $10,000 bond from “ABC Inc.” that pays 4% for the next 10 years.  The next month, interest rates go up.  Now you can buy a $10,000 bond from “ABC Inc.” that pays 5% for the next 10 years.  If Sarah tries to sell you her “ABC Inc.” bond for $10,000 that only pays 4%, would you pay her $10,000 for it?

The answer is no, because you can buy a $10,000 bond from “ABC Inc.” that will pay you 5%.  So, how can Sarah sell her bond?

She will have to discount it or sell it for $9,000 to get you to buy it. 

However, Sarah does not have to sell you her bond.  She can continue to keep it and make 4%, but the value of her bond has gone down because interest rates have gone up.

Bonds are not the only assets that are sensitive to interest rates.  You will see a similar inverse price relationship with real estate, utilities, telecom, and preferred stocks.

Over the last 12 months, the 10-year treasury rate has gone from 2.87 to 1.55.  Interest rates are now well below historical averages, which means interest rate sensitive holdings will have a headwind moving forward when rates go up in the future. This topic is one that our AP Wealth investment committee is discussing on a regular basis.

Please do not hesitate to reach out to us if you have any questions. You may reach us at the office at (706) 364-4281.

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