Financial Information
Fixed income and interest rate change?
Hello, I heard recently that if there is an increase in the interest rate that the value of fixed income products like bonds would decrease and therefore one should stay away from bonds. Can someone please explain the logic behind this principle if it is in fact true? If you have a source for reference that would be useful also.
Yes, it is true — it is a basic fact of finance 101: the current value of a bond is inversely related in a formulaic way to the relationship between the rate of interest the bond pays and the current market interest rate.
If current interest rates are higher than the rate on a bond, the value of the bond will go down; if lower, the value will do up.
However, (1) predicting interest rates is about as difficult as predicting the future changes in a particular index or stock and (2) the particular value of a bond investment depends up on the investor and the bond.
Hopefully, (1) is self explanatory. No one can say what will happen with a high enough degree of certainty to ethically call it a fact…at best it is an educated guess.
Point (2) is worth mentioning. Direct ownership of bonds with near zero risk of default (government bills, notes, & bonds) and very low rates of default (investor grade corporates, government agency bonds, & high grade muni bonds) have a place in some investment portfolios if the intention is to hold them to maturity for security and income. This is because high grade instruments will generally pay off at face value at maturity (not market value). If the assets are held to maturity, no loss of investment will occur.