By Terry Savage on October 28, 2016 | Investments

Do Bonds go up or down when the interest rate goes up?

Terry Says

This is an important concept for everyone to understand: When Interest Rates go UP,  Bond PRICES go DOWN! Let me explain.  Suppose you take $10,000 and buy ten $1,000 10- year U.S. Treasury note today, carrying a fixed interest rate of 1.75%, which  is the current rate.  There is no doubt that the U.S. Treasury will continue to pay the interest, and that it will repay your $10,000 investment in 10 years when the bonds mature. But let's suppose that interest rates in general start to rise in the next few years, perhaps because of a return of inflation.  (People lending money by buying bonds will want a higher interest rate to offset perceived future inflation.)   So the Treasury sells more 10-year bonds in 2018, perhaps with an interest rate of 3 percent. And at just that moment, you decide you want to sell your 1.75% bonds.  No one is going to give you $10,000 for them because they could take their money and buy a 3% Treasury bond.  They might offer to pay you only $8000 for your bonds(a price of $800 for each $1,000 bond). When interest rates go up, existing fixed, low rate bonds are less attractive to buyers, and so their market price falls.   And the longer the "maturity" of the bond, the larger the price drop.



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