Bond prices change based on several factors, including interest rates, maturities, and payment risk. This blog post analyzes the impact of these factors on bond values and looks at key points to consider when investing.
Bonds are securities issued to raise funds for business purposes. Bonds come in different types, such as government bonds and corporate bonds, depending on the issuer. The payment terms, such as the face value, interest rate, and maturity date, are determined when the bond is issued. Bondholders receive regular interest payments after the bond is purchased and receive the final interest amount and face value on the maturity date. The amount of interest is usually paid annually as the par value multiplied by the interest rate.
Bonds are sometimes traded before their maturity date, and the price of the bond is determined by several factors, including current value, maturity, and risk of default. In particular, changes in market interest rates have a significant impact on the price of bonds. When interest rates rise, the current value of the bond falls and the price of the bond also falls. Because of this volatility, bond investors must carefully monitor market conditions.
Bond investors are concerned with the net yield, which is the sum of the interest payments to be received on a regular basis and the face value of the bond, each valued at the current point in time, minus the purchase price of the bond. Interest rates are taken into account when valuing the amount to be received in the future by converting the amount to present value. For example, if the interest rate is 10% per year and the amount to be received next year is $110, the present value of $110 is $100. In other words, interest rates have an opposite effect on the present value.
Therefore, when interest rates rise, the present value of bonds falls, which in turn causes the price of bonds to fall. Thus, market interest rates, which fluctuate from time to time, are a factor that affects the change in bond prices due to the present value valuation structure.
Maturity, which is the period from the time of purchase to the maturity date, also affects the price of the bond. In general, the longer the maturity, the more sensitive the price is to interest rate changes and the greater the risk of price volatility, all other payment terms being equal. Bonds with longer maturities offer investors greater returns, but they also carry greater risk, so investors should make their decisions carefully. Bonds have shorter maturities after they are issued, so the price of the bond becomes less sensitive to interest rate changes as the maturity date approaches.
Therefore, investors prefer bonds with higher nominal interest rates because they expect higher net returns on longer-term bonds. This can be an attractive option for investors seeking stable income over the long term.
The risk of insolvency, where the face value and interest payments cannot be made on the agreed date, also affects the price of the bond. For example, if the business environment of the company issuing the bond deteriorates, the company may become less able to pay. Investors in such bonds must take risks and demand compensation, so the bond price is set relatively low.
On the other hand, bonds are among the financial assets that can be substituted for each other, so their prices can be affected by the situation in other asset markets. For example, if the stock market is booming and the return on stock investment increases, the demand for bonds may decrease, causing the price of bonds to fall. For this reason, bonds and stocks are considered conflicting investment options, and investors construct their investment portfolios by considering the level of risk they are willing to take and their expected return.
Bond investing requires careful analysis and judgment because of the complex interplay of these various factors. Understanding the basic concepts and characteristics of bonds, as well as the economic environment and market conditions, is essential to successful investing.
