Bonds Interest Rates
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Bonds are fixed income securities that offer stable and predicted returns in a fluctuating interest rate environment. Although bonds are considered to be risk-free investments, there are still certain risks involved. While the coupon rate, or the interest rate, will not change in a fixed rate environment, the value of the bonds can change, based on interest rate fluctuation.[br]
Bonds Interest Rates – Relationship between Bond Prices And Interest
The coupon rates of bonds are close to the market rate when the bonds are issued. Bond prices and interest rates are inversely related. That means when the interest rate increases, the bond price will decrease. When the interest rate decreases, the bond price will increase since bond prices are based on the potential income they produce, or opportunity costs. For example, if you invest $100,000 during the first year with a coupon rate of 5%, your interest income will be $5,000. If the market interest rate declines to 1%, you will still get $5,000 in interest income, but the value of your bonds has changed. If another investor wants to earn $5,000 in a year he or she should invest $500,000 to earn $5,000.
Now if any investor comes to you to buy your bonds you will not sell them for less than $500,000 because you know that the investor has to spend more than $500,000 to get an income of $5,000 in a year elsewhere. In year three, if the interest rate rises to 10%, the value of your bonds will be $50,000. Here, one needs to invest only $50,000 to earn an interest income of $5,000 in a year. Despite interest rate fluctuations, you will get your $100,000 if you hold your bonds until maturity.[br]
Most investors do not want to hold their fixed income securities until maturity and look for quick profits out of their current investments. If you are willing to take risks, you can earn the same amount of money (from bonds) that anyone would make with high-risk investment vehicles, such as equities and commodities.
As an investor, you should constantly compare returns on your current investments to other investment opportunities in the market. If interest rates are going to increase for many years constantly, it is better to invest in short-term bonds and invest in long-term bonds only when the interest rates are peaked.
