This Bonds Investment 101 article is a follow up to our previous “Should Investors Continue Investing in Bonds in the Current Environment?”
What are Corporate Bonds? | Government Bonds?
Bonds are basically loans that investors give to governments (Sovereign Bonds) or companies (Corporate Bonds). And since governments and businesses are always in need of money, they keep issuing new bonds.
Bonds Pricing – Interest Rate Impact
If the interest rate they offer on newer bonds is higher than the (older) ones you hold, your bond investment won't be as attractive for buyers (if you tried to sell). That's because they'd much rather own something that offers a higher rate of interest – like the new ones the government or company issued. However, your bonds may still be attractive to some buyers if you agree to sell them at a lower (discounted) price than what you bought them at (face value).
The inverse is true if new bonds are issued at a lower interest rate than the ones you hold. In that case, investors would much rather hold higher-paying bonds than buy the new ones that offer them a much lower yield. In a situation like this, where interest rates decline, your older bonds will be prized higher, and investors will be more willing to pay a higher (premium) price to own them.
The above is a very simplistic scenario, because in real life there are other variables that come in to play (Duration, Maturity, Yield to Maturity, etc.) to determine what a bond's value will be. However, in general terms, rising interest rates (Yield) mean a decrease in bond values, and vice versa.
Today's Economic Climate
Today, we are in a world of low interest rates all across the world. Ignoring the fact for a moment that rates are beginning to rise in the U.S., there are not many countries where investors are getting interest rates on their deposits in the high single digits. So long as interest rates remain low, your bond values are likely to either remain stable or rise.