Money Smarts

Chapter 10 Money Smarts: Bond Prices: Up or Down?

Suppose you have a bond that you are getting ready to sell. Suddenly interest rates go up. Will the price of your bond also go up? No. Bond prices and interest rates move in opposite directions.

The current value of a bond depends on the difference between the stated interest rate on the bond and the actual interest rate on the market today. The stated interest rate remains the same, but the market interest rate changes continuously. The only way the value of a bond can adjust for market rate changes is for the market price of the bond to change.

If investors can buy a new bond (for example, a bond just issued today) and earn a rate higher than your bond’s interest rate, your bond’s market value falls. If the new bond pays a lower rate than your bond, the market value of your bond increases. If you own a bond with a stated interest rate of 5 percent and an investor can earn only 4 percent on a new bond, the selling price of your bond increases.

Go to the BusinessWeek Online Personal Finance Investing calculators. Scroll down to the Bond Calculators and click on “How will rate changes affect my bond’s current value?”

Input the following values:

Click on the “get your results” button and answer the following questions.

1. What is the bond’s value if today’s market interest rate is 5.5 percent? What is the loss on the bond if you sell it today?
2. What is the bond’s value if today’s rate is 3.50 percent? What is the gain?
3. Click on the INPUTS tab and change today’s market rate to 6.00 percent. If rates stay at 6 percent, what is the gain or loss on the sale of the bond?
4. When this bond was bought at 105, how much did the buyer pay?
5. At a bond price of 105, do you think the market interest rate was higher or lower than the bond’s stated interest rate? Why?