Bond Market Math (Part 2)

If rates are rising, how do bond investors make money?

When rates go up bond market values go down. The return from bonds doesn’t come from the market, but from the coupon. That’s the interest rate promised when a loan is first made, and it compensates investors for the risk.

So in order to invest profitably it’s important to understand the risks involved. Bonds have three principal types of risk: interest rate risk, credit risk, and structural risk. Interest rate risk is clear: bond prices go down when interest rates rise. The longer the bond, the more the price declines for a given interest rate move. For example, a five-year treasury will fall 4.7% if rates rise 1%, while a 30-year bond will fall 15.7%.

That’s why long bonds yield more than shorter bond normally—to compensate investors for the greater risk. But with rates rising, investors have to find other sources of return. So credit risk and structural risk are crucial: sources of risk can also be sources of return. As rates rise, structure and credit become the key to unlocking future bond market performance.

Douglas R. Tengdin, CFA

Chief Investment Officer

By | 2013-10-04T09:36:15+00:00 October 4th, 2013|Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. - Leave a comment if you have any questions—I read them all! - And Follow me on Twitter @GlobalMarketUpd

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