The biggest economic threat to bonds is rising interest rates.
The biggest economic threat to bonds is rising interest rates. For a wealth of detailed investment insights and successful investor profiles, go to Investor Education. These may make you reconsider whether to purchase a long-term bond. However, they are vulnerable to economic changes that can undermine their value. If you plan to trade bonds, be sure you understand the interest rate risks involved and how holding long-term bonds increases that risk. The inverse relationship is easy to see with this simple illustration. If the issuer is financially strong, investors are confident that the issuer will be capable of paying the interest on the bond and pay off the bond at maturity. If interest rates went down instead of up, you could then sell your bond at a premium over face value because the fixed interest rate would be higher than the market rate.
If so, the price they are willing to pay for the issuer's bonds may drop. If the issuer encounters financial problems, or if investors think that it might, then investors may become less confident in the issuer. If you own a bond and interest rates go up, the value of your bond on the open market, with few exceptions, will go down. Other yield curves are possible, signifying that long-term yields are not higher than short-term yields.
Bonds provide an element of stability that offsets some of the volatility of stocks. While current yield is easy to calculate, it is not as accurate a measure as yield to maturity. Yield to maturity is often the yield that investors inquire about when considering a bond. Price is important when you intend to trade bonds with other investors. Because of the interest rate risk, bonds with longer terms are more risky than bonds with shorter terms. Yield and price Whichever way you calculate yield, the higher the price you pay for a bond, the lower the yield, and vice versa.
Conversely, when interest rates fall, an existing bond's coupon rate becomes more appealing to investors, driving the price up.