“Bond values go down when interest rates go up.”

Question

I was reading this article in the Motley Fool about Silicon Valley Bank’s closure and in this paragraph was a bunch of terms that I couldn’t wrap my head around. But the thing that got me was: “bond values go down when interest rates go up.”

Can someone explain *why* bond values go down when interest goes up? And what crash course on economics I should take to get a handle on all this?

Excerpt from article:

>”This is where Silicon Valley Bank went wrong. It bought too many higher-yielding held-to-maturity (HTM) assets that were meant to be — as their classification suggests — held until they mature; this maturity could be as much 30 years into the future. The over-commitment to the wrong long-term assets subsequently prevented the bank from buying enough shorter-term, available-for-sale (AFS) bonds and debt instruments that (if necessary) could have been sold to fund customer withdrawals. Less than one-fourth of SVB’s securities backing customer deposits were of the available-for-sale variety, in fact. Aggravating the misstep was the purchase of fixed-income instruments that proved overly sensitive to rate hikes. Remember, bond values go down when interest rates go up.
>
>It was this unhealthy mix of assets that would eventually deal the death blow.”

In: 8

Answer 1

You bought a magic widget last year. It spits out $5 a year, and it cost you $100.

This year’s magic widgets are better, they still cost $100 but now spit out $10 a year.

Nobody will buy your old widget for $100. If you want to sell it, nobody wants to buy it for more than $50. Without such a discount, it’s not competitive with the new ones.

Last year, your situation was solid:

– Your main plan was to wait patiently for decades and watch your widgets slowly pay for themselves, then start giving you free money.
– Your backup plan, if you needed money, was to sell the widgets. You did the math, and calculated your widgets’ total value was more than you could ever possibly need.

This year, you have an enormous problem:

– You’re a bank, which means you owe money to many people who could ask for it at any time (“depositors”).
– Lots of them are asking for it; you suddenly need large amounts of money. Your main plan isn’t feasible anymore; you need money now and can’t wait.
– Selling widgets isn’t feasible either. Because your widgets are now only worth $50, selling them all won’t give you enough to repay everyone you owe.