Interest Rates and Bond Prices
The first reason for prices of bonds fluctuate has to do with the inverse relation there is between bond prices and the rates of interest in the market. When rates of interest in the market boost, existing bond prices drop; when rates of interest in the market fall , the prices of existing bonds go upward.
The extension of these changes in bond prices are determined by the coupon rates of the bonds. This relation between rates of interest and coupon rates of bonds determine if the bonds are negotiated at a discount or at a premium price.
- Discount. Bonds are negotiated at discount when coupon rates are lower than the rates of interest in the market.
- Discount. When the yield-to-maturity of the bond (ask yield or bid yield) is greater than the coupon rate, the bond is generally negotiated at discount.
- Premium. Bonds are negotiated at a premium price when coupon rates are higher than the rates of interest in the market.
- Premium. A bond is generally negotiated at a premium when its yield-to-maturity is lower than the coupon rate.
Interest rates and maturity
A second reason for fluctuations in prices of bonds is the relation between rates of interest and how long to maturity.
Some bonds are more sensitive than others to changes in rates of interest due to the differences in their maturity periods. For example, two bonds with the same coupon rate, but with different periods of maturity react differently under changes in rates of interest.
It is not only the bond that has longer time to maturity, and more volatile than a bond of less time to maturity, but the magnitude of the changes in its price are also greater for bonds with longer terms to maturity.
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