Why bond prices fall when yields rise
The seesaw between bond prices and yields explained with a worked example, plus what duration tells you about the size of the move.
A bond is a loan. You lend money, receive interest payments called coupons, and get the face value back at maturity. The coupon on an existing bond is fixed, but the market price of that bond moves every day. The reason is the yield.
The seesaw
Yield is the return you would earn if you bought the bond at today's price and held it to maturity. When new bonds start paying more, older bonds with lower coupons become less attractive, so their prices fall until their yields line up with the market. When market rates fall, the reverse happens.
A worked example
Take a 10-year bond with a $1,000 face value and a 4.5% coupon, paid twice a year. If the market yield for similar bonds is 5%, the bond is worth about $961. If the yield rises to 6%, it is worth about $888. If the yield falls to 4%, it is worth about $1,041.
You can check these with the bond price calculator.
Duration
Duration is a measure of how sensitive a bond's price is to a change in yield. A bond with a modified duration of 8 will lose roughly 8% of its price if yields rise one percentage point, and gain roughly 8% if they fall one point. Longer maturities and lower coupons mean higher duration.
Other risks
- Credit risk. The issuer might not pay. Government bonds from stable countries carry little of this; corporate and lower-rated bonds carry more.
- Inflation risk. Fixed payments buy less when prices rise.
- Reinvestment risk. When rates fall, the coupons you receive earn less when reinvested.
Holding to maturity
If you hold an individual bond to maturity and the issuer pays, you receive the face value regardless of price swings in between. Bond funds have no maturity date, so their prices keep moving with yields.