Making Money With Bonds(Part 2)
The value of a bond is determined by the interest rate it pays and by what's happening in the economy. A bond's interest rate never changes eventhough other interest rate do. If the bond is paying more interest than is available elsewhere, investors will be willing to pay more to own it. If the bond is paying less, investors won't buy it unless you sell it at a bargain price or lower than the value of the bond.
Interest rates and bonds prices fluctuate like two sides of a seesaw. When interest rates drop, the value of existing bonds usually goes up. When rates climb, the value of existing bonds usually falls.
Several factors including yield and return affect whether or not a bond turns out to be a good investment.
If the bond investor buys at par, and holds the bond to maturity, inflation, or the shrinking value of the currency, is the worst enemy. The longer the maturity of the bond, the greater the risk that at some point inflation will rise dramatically and reduce the value of the money that the investor is repaid.
If the bond pays more than the rate of inflation, the investor comes out ahead. For example, if a bond is paying 8% and the annual rate of inflation is 3%, the bond produces real earnings of 5%. But if inflation shoots up to 10%, the interest earnings won't buy what they once did. And in either case, the principal invested in the bond also shrinks in value.
Interest rates and bonds prices fluctuate like two sides of a seesaw. When interest rates drop, the value of existing bonds usually goes up. When rates climb, the value of existing bonds usually falls.
Several factors including yield and return affect whether or not a bond turns out to be a good investment.
If the bond investor buys at par, and holds the bond to maturity, inflation, or the shrinking value of the currency, is the worst enemy. The longer the maturity of the bond, the greater the risk that at some point inflation will rise dramatically and reduce the value of the money that the investor is repaid.
If the bond pays more than the rate of inflation, the investor comes out ahead. For example, if a bond is paying 8% and the annual rate of inflation is 3%, the bond produces real earnings of 5%. But if inflation shoots up to 10%, the interest earnings won't buy what they once did. And in either case, the principal invested in the bond also shrinks in value.
