Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2017 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.

Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
Bond prices and interest rates - Views on News from Equitymaster
  • E-MAIL
  • A  A  A
  • Dec 16, 2010

    Bond prices and interest rates

    Why do bond prices have an inverse relationship with interest rates? While it seems illogical that the value of a bond will fall when interest rates increase and rise when the interest rates fall, on close examination it makes sense. In this article we will explain to you how this works.

    For this, we will consider a zero coupon bond. A zero coupon bond does not pay coupons (or interest payments). These bonds return the accrued interest and principal (or par value) to the investor at the time of maturity. Zero coupon bonds derive their value from the difference between the purchase price and the par value (also the face value of the bond) paid at maturity.

    Let us assume that a hypothetical company had to raise money. For this it issues a zero coupon bond with a par value of Rs 1,000 and a coupon rate of 10% with a maturity of 2 years.

    The price at which the bond should trade is derived by the following formula.

    Par Value
    (1+coupon rate)^time for maturity

    Using this formula (1000/(1+10%)^2), we arrive at a price of = Rs 826

    Hence when issued, an investor will buy this bond at Rs 826 which is a discount to par value. This will be as only at this price, the investors will receive 10% returns on his investment when the bond matures. However, say the interest rates go up and the same company now has to pay 15% to raise money. A bond investor like an equity investor also seeks to maximise his return. Hence, in case an investor now buys the same bond, he will pay only Rs 756. This is because only at this rate will he be able to receive 15% on his investment. Hence when interest rates move up, the value of the bond falls.

    Similarly, if the interest rate falls to 5%, the bond's value will increase. A 10% coupon bond will be more attractive in the market as the bonds are now being issued by the same company with a coupon rate of only 5%. Hence an investor will pay more for the 10% bond. By our calculation, the bond will now be worth Rs 907.


    We have seen how bond prices are affected when interest rates move. With a number of companies now issuing bonds, an investor should keep this basic relationship in mind for investing profitably.



    Equitymaster requests your view! Post a comment on "Bond prices and interest rates". Click here!

    2 Responses to "Bond prices and interest rates"


    Dec 22, 2010

    Rule of thumb, longer the period more the risk. Hence investors would seek a premium for that. Higher rate of return for long term bonds is expected, but comparing two offerings of different maturity is speculative as it depends on how interest rates pan out in future.


    Regular reader

    Dec 16, 2010

    What about the time value of money? How is the comparison done between zero coupon bond effectively paying 10% and maturing in the next two years and another bond effectively paying 15% but maturing in 10 years from now? How does maturity period impact the price of a bond?

    Equitymaster requests your view! Post a comment on "Bond prices and interest rates". Click here!

    More Views on News

    Tejas Networks Ltd. (IPO)

    Jun 14, 2017

    Should you subscribe to the IPO of Tejas Networks Ltd?

    Discover the Secrets of Hidden Smallcaps From These AGMs (The 5 Minute Wrapup)

    May 26, 2017

    Don't be surprised to come across some Super Investors there!

    A Trader's Nightmare. A Business Owner's Delight. (The 5 Minute Wrapup)

    May 19, 2017

    Not all small-cap investors see themselves as traders. Some see themselves as business owners.

    Securities & Intelligence Services Ltd. (IPO)

    Jul 31, 2017

    Should you subscribe to the IPO of Securities & Intelligence Services Ltd?

    Why Super Investors are Underperforming in This Market (The 5 Minute Wrapup)

    Jul 8, 2017

    If Super Investors can wait for the right pitch, so can you.

    More Views on News

    Most Popular

    This Small Cap Can Drive Chinese Players Out of India (and Make a Fortune in the Process)(The 5 Minute Wrapup)

    Aug 17, 2017

    A small-cap Indian company with high-return potential and blue-chip-like stability is set to supplant the Chinese players in this niche segment.

    Dear PM Modi, India is Already Land of Self-Employed, and It Ain't Working(Vivek Kaul's Diary)

    Aug 21, 2017

    Most Indians who cannot find jobs, look at becoming self-employed.

    It's the Best Time to Buy IT Stocks(Daily Profit Hunter)

    Aug 16, 2017

    The IT Sector could be in an uptrend till February 2019. Are you prepared to ride the trend?

    Think Twice Before You Keep Money In A Savings Bank Account(Outside View)

    Aug 22, 2017

    Post demonetisation, a cut in bank savings deposits rates was in the offing.

    5 Steps To Become Financially Independent(Outside View)

    Aug 16, 2017

    Ensure your financial Independence, and pledge to start the journey towards financial freedom today!

    Copyright © Equitymaster Agora Research Private Limited. All rights reserved.
    Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement.

    LEGAL DISCLAIMER: Equitymaster Agora Research Private Limited (hereinafter referred as 'Equitymaster') is an independent equity research Company. Equitymaster is not an Investment Adviser. Information herein should be regarded as a resource only and should be used at one's own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute investment advice or a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Before acting on any recommendation, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. This is not directed for access or use by anyone in a country, especially, USA or Canada, where such use or access is unlawful or which may subject Equitymaster or its affiliates to any registration or licensing requirement. All content and information is provided on an 'As Is' basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results.

    SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.

    Equitymaster Agora Research Private Limited. 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
    Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: info@equitymaster.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407

    Become A Smarter Investor In
    Just 5 Minutes

    Multibagger Stocks Guide 2017
    Get our special report, Multibagger Stocks Guide (2017 Edition) Now!
    We will never sell or rent your email id.
    Please read our Terms