3 factors that affect bond prices

1. Interest rates

In general, when interest rates rise, bondBond A kind of loan you make to the government or a company. They use the money to run their operations. In turn, you get back a set amount of interest once or twice a year. If you hold bonds until the maturity date, you will get all your money back as well. If you sell…+ read full definition prices fall. When interest rates fall, bond prices rise.

Example – You own a bond paying 3% interest. When interest rates are low – say 1% – your interest rateInterest rate A fee you pay to borrow money. Or, a fee you get to lend it. Often shown as an annual percentage rate, like 5%. Examples: If you get a loan, you pay interest. If you buy a GIC, the bank pays you interest. It uses your money until you need it back.+ read full definition is higher than the going rate. This makes your bond attractive to other investors. But if interest rates rise to 5%, your bond is less attractive.

2. Inflation

In general, when inflationInflation A rise in the cost of goods and services over a set period of time. This means a dollar can buy fewer goods over time. In most cases, inflation is measured by the Consumer Price Index.+ read full definition is on the rise, bond prices fall. When inflation is decreasing, bond prices rise. That’s because rising inflation erodes the purchasing power of what you’ll earn on your investmentInvestment An item of value you buy to get income or to grow in value.+ read full definition. In other words, when your bond matures, the return you’ve earned on your investment will be worth less in today’s dollars.

3. Credit ratings

Credit ratingCredit rating A way to score a person or company’s ability to repay money that it borrows based on credit and payment history. Your credit score is based on your borrowing history and financial situation, including your savings and debts.+ read full definition agencies assign credit ratings to bond issuers and to specific bonds. A credit rating can provide information about an issuerIssuer An organization that offers securities for sale to investors. Examples: corporations, investment trusts and government bodies.+ read full definition’s ability to make interest payments and repay the principalPrincipal The total amount of money that you invest, or the total amount of money you owe on a debt.+ read full definition on a bond. In general, the higher the credit rating, the more likely an issuer is to meet its payment obligations – at least in the opinion of the rating agency. If the issuer’s credit rating goes up, the price of its bonds will rise. If the rating goes down, it will drive their bond prices lower. Learn more about credit ratings.

3 key points

Factors affecting bond prices:

  1. Interest rates,
  2. Inflation,
  3. Credit ratings.
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