Essays on How Changes in Interest Rates Would Affect Bond Prices Report

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The paper "How Changes in Interest Rates Would Affect Bond Prices" is a wonderful example of a report on macro and microeconomics. Bonds play a vital role in an investor portfolio. However, bonds are susceptible to economic changes that can affect their value. An investor with bonds is able to reduce his or her overall risk by diversifying his or her holdings. The biggest threat to bond yield is raising interest rates. Before investing in the stock market, people need to understand the fundamentals- including rewards and potential risks.

When bonds are compared to shares, they sit at the middle to lower end of the risk spectrum; cash is seen as a lower risk investment than bonds (Amihud, 2002). The price of a bond may go up and down in response to two factors: change in credit quality and interest rates. Investors in the bond market tend to worry about the safety of their investment. Many Australians who have invested in bonds do not comprehend how a change in the interest rate will have an effect on the bond price (Ripley, 1997).

Since the early 1980s, interest rates have been widely used to determine the return on bond investments. The paper will use practical worked numerical examples to explain how changes in interest rates would affect bond prices. Bond YieldFor an investor, bond yield is the anticipated return on investment, the yield is usually expressed as a yearly percentage. For example, a 7 % bond yield means that the investment on the bond average 7% per year. There are many ways in which bond yields can be calculated, but whichever way bond yields are calculated, the relationship between bond yields and the price remains constants: Rule # 1: the price of the bond is opposite to the interest rates (Park and Reinganum, 1986).

In other words, if the interest rate of a bond is increased the bond value will decline, and if the interest rate is failing the bond value will increase. Change in interest rates is always the largest factor in the total return performance calculation of bond yield.

References

Amihud, Yakov, 2002, Illiquidity and stock returns: cross-section and time-series effects,

Journal of Financial Markets 5, 31-56.

Houweling, Patrick, Mentink, Albert, and Vorst Ton, 2005, Comparing possible proxies of

corporate bond liquidity, Journal of Banking & Finance 29, 1331-1358

Park, S.-Y. and M. Reinganum, 1986, “The Puzzling Price Behavior of Treasury Bills that

Mature at the End of Calendar Months,” Journal of Financial Economics, 16, 267-283.

Ripley, William, 1997, Railroads: Finance & Organization. New York: Longmans, Green, &

Co.. pp. 106–107.

Temal, J. Wesalo, 2001, The Fundamentals of Municipal Bonds: The Bond Market

Association. John Wiley and Sons, Inc.. p. 49

O'Hara, Neil, 2012, The Fundamentals of Municipal Bonds. Hoboken, NJ: John Wiley & Sons,

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