Understanding

Bond and interest

rate connection

By Shweta sharma
 Bond Basics
Bonds are debt securities issued by
governments, corporations, or
municipalities to raise capital. When
you buy a bond, you are essentially
lending money to the issuer.

Since you are lending money to the

issuer, they pay you back a certain
amount of extra money for that which
is known as coupon rate or yield. This
rate is crucial because it determines
the income you receive from holding
the bond.

By Shweta sharma
 Inverse relationship
b/w bond and
interest rate
Bonds and interest rates generally
have an inverse relationship, meaning
that as interest rates rise, bond prices
tend to fall, and vice versa.

Why?
When interest rates rise, new bonds
are issued at higher interest rates to
match the prevailing market rate.

This makes the old bonds with low-

interest rates less attractive to the
investors as they generate lower
income compared to new bonds.

Consequently, demand for old bonds

falls, and therefore their prices also
fall.

By Shweta sharma
 Yield-to-Maturity
Yield-to-maturity (YTM) is the total
return an investor can expect from
holding a bond till maturity.

Interest rate Bond price YTM

Interest rate Bond price YTM

YTM

By Shweta sharma
 Price Sensitivity
The price sensitivity of bonds to
interest rate changes varies based on
factors such as the bond's maturity,
coupon rate, and prevailing market
rates.

Longer-term bonds are generally more

sensitive (Volatile) to interest rate
fluctuations than shorter-term bonds,
as there is more time left till maturity
for price fluctuations.

By Shweta sharma
 Inflation Impact
Inflation or expectation of future
inflation plays a role in this
relationship. If investors anticipate
higher inflation, they may demand
higher interest rates on bonds to
compensate for the eroding purchasing
power of the bond's fixed payments.
This can lead to lower bond prices.

By Shweta sharma
 Other factors
Market forces, economic indicators,
central bank policies, and geopolitical
events influence interest rates and,
consequently, bond prices. Changes in
these factors can trigger fluctuations in
the bond market.

By Shweta sharma
 Impact on Investor
Returns
This relationship i.e. bonds and interest
rates has a direct impact on investor
returns. If an investor holds a bond till
maturity, they will receive the bond's
face value regardless of market price
fluctuations.

However, if the investor sells the bond

before maturity, the selling price will
be influenced by the prevailing interest
rates, potentially leading to capital
gains or losses.

By Shweta sharma
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By Shweta sharma