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.
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>It was this unhealthy mix of assets that would eventually deal the death blow.”
In: 8
I think the typical layman confuses two topics with bonds. 1) What is the bond worth at maturity and 2) What is the bond worth today
I think lots of people get confused about number 1: You buy a bond for $100 that pays 5% interest and matures after 1 year. After 1 year you collect $105. This arrangement never changes regardless of interest rate hikes or macroeconomic trends or any complex issue you may have read about. Once you buy the bond, your “deal” is locked in.
The crux of the issue is scenario 2: What is the bond worth today. If you buy a bond for $100 that pays 5% interest, but a month later you decide to sell it it should be worth a tiny bit more than $100 (since its that much closer to collecting that $105). But! if rates have gone up to 10% now people can spend their $100 on these new bonds and get $110 in a year instead of $105… Well then if I can spend $100 and get $110 in a year I’m definitely not giving you $100 just to get $105. So if you want to sell your old bond you have to give me a discount to make it worth my while. So the CURRENT value of your bond goes down
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