| Why is it that bond prices go the opposite
direction from bond yields? |
|
When a bond is first sold as a
part of a new issue, the price is fixed. From then on,
the price of a bond moves up or down in relation to
changes in the general level of interest rates. When
interest rates rise, the price of a bond goes down
because its coupon rate (the fixed, periodic payment)
becomes less desirable than the higher rates of newly
issued bonds of similar quality. If interest rates fall,
the bond's coupon rate becomes more attractive to
investors, which drives up the price. If the yield to
maturity is greater than the coupon rate the bond will
sell at a discount to its maturity price. If the yield
to maturity is less than the coupon rate, the bond will
sell at a premium to its maturity price.
Also, the longer the maturity of the bond, the more its
price tends to be affected by changes in interest rates.
For example notice what happens to the price of three
different bonds.
| |
5.00%
YTM* |
5.50
YTM* |
6.00%
YTM* |
| 2
yr bond, 6% coupon |
101.88 |
100.93 |
100.00 |
| 10
yr bond, 6% coupon |
107.79 |
103.80 |
100.00 |
| 30
yr bond, 6% coupon |
115.45 |
107.30 |
100.00 |
| 10
yr bond, zero coupon |
61.03 |
58.13 |
55.37 |
| 30
yr bond, zero coupon |
22.73 |
19.64 |
16.97 |
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* YTM - yield to maturity,
assumes no early call option. Price is $ per $100.
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