How Do Interest Rates Affect Bonds?

October 04, 2022

How do interest rates affect bonds? We discuss this topic in today's Arista Advice.

Full Transcript:

Hello, welcome to Arista Advice. Question of the week is: "Paul, how do interest rates affect bonds?"

Let me share with you a quick story. I've been on the floor of the New York Stock Exchange probably three to four times. I was on the floor of the New York Stock Exchange on September 1, 2001, 10 days before the Twin Towers were hit by two commercial aircrafts. But the bond market, where bonds are traded, is up in Chicago. Not a lot of people know this. The wealth that is up in Chicago is almost four to one of what the money is invested on the stock market. So a lot of money's in Chicago, and interest rates and bonds and treasury bills and treasury notes, commercial paper, options, futures are all traded in Chicago, but let's get back to the question of the week.

Question of the week is - "Do interest rates affect bonds?" and the answer is yes, yes, yes. Painfully yes. As you'll see here when interest rates go up 1% or they fall 1%, you can see that a 2-year treasury, up at the top, or a 30-year treasury, which has the biggest magnified movement. If interest rates go up one, 30-year treasury bonds will be affected the most to the tune of over 24%, and conversely on the downside, if interest rates go up 1%, the 30-year bond will go down 13%.

So year to date, there's a lot of pain in the 30-year bond, and also in the 20-year bond and in the 10-year bond because interest rates have been going up. Also, in this chart, you'll see that US junk bonds, municipal bonds, as rates go down, municipal bonds go up, and as interest rates go up, municipal bonds go down 3.5%. So, as we've seen interest rates already increased four times this year, of anywhere from a quarter to three quarters, municipal bonds, corporate bonds, any type of fixed income security will feel the pain.

That's why it's important to keep short duration or intermediate duration of all type of fixed income. So in speaking with your professionals and other leading advisors have a conversation of what will happen if interest rates go up or interest rates go down.

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