Two major factors cause bonds prices to fluctuate, interest rates and risk. Bond prices (not to be confused with bond yields) have an inverse relationship with both interest rates and risk. That means, as one goes up the other goes down.
Risk and bond prices
Generally, the higher the risk of a bond, the lower the bond price, but the higher the coupon rate (amount of interest payable to the creditor/ investor). This is because the risk of losing the initial investment is higher, and therefore the bonds themselves are worth less.
As the risk decreases, the bond becomes more valuable and the bond price increases. This is because the market ‘prices in’ the fact that as risk decreases, and the bond is worth more as the company is more likely to pay back the face value at the maturity date.
Interest rates and bond prices
The higher the underlying central bank cash rate (e..g the RBA Cash Rate), and therefore interest rates on lending, the lower the price of the bond. When bond prices are low, coupon rates (amount of interest payable) are higher. This is because the investment is seen as riskier (issuers need to pay higher interest for debt) and therefore the “loan/ debt” (security/bond) is seen as less valuable.
If the interest rate on newly-issued bonds is lower than the interest rate paid on existing bonds, the value of the existing bonds will increase. This is to ensure the market is not unfairly balanced toward the purchasing of newly-issued bonds.
It’s important to fully understand the impact on bond prices of both a lower interest rate and a higher interest rate. If you’d like to know more about how bond prices work, contact an ABE investment adviser today
Credit rating and bond prices
If the issuer’s credit rating is high or improves, it is more likely that the issuer will be able to make the required interest payments on the bond. As such, the credit risk of issuers can have a substantial impact on how bonds are priced.
If an issuer has a low credit risk, and is more likely to repay the debt in full, this decreases the risk and increases the price (and value) of the bond. If the issuing company’s credit rating declines, the increased risk can cause the price (and value) drop.
Disclaimer: This document has been prepared by ABE Distribution Pty. Ltd ACN 673 177 912 Corporate Authorised Representative 1307088 (“ABE”) and is of a general nature only. It was prepared without considering your financial needs, circumstances and objectives. Before investing in a fixed-interest product with ABE, you should consider whether it is appropriate for your circumstances and review the relevant terms and conditions. This document contains links to other third-party websites, some of which require a subscription to read. Such links are for your convenience only, and ABE does not recommend or endorse these third-party sites.. No representation or warranty is made as to the accuracy, completeness or reliability of any estimates, opinions, conclusions, or other information contained in the content. The content may contain certain forward-looking statements. Forward-looking statements are not guarantees of future performance and involve known and unknown risks, uncertainties, and other factors, many of which are beyond our control. To the maximum extent permitted by law ABE disclaims all liability and responsibility for any direct or indirect loss or damage that you may suffer as a result of relying on anything in this content. Past performance is not an indication of future performance