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
Let’s say I buy a $1000 bond paying 3% interest last year. Now, rates for newly issued bonds are 6%.
Why would anybody buy my 3% bond for face value if they can buy a newly issued one that pays 6%?
So if I want to sell, I would need to lower the price I am willing to get such that the purchase price makes the effective interest payment 6% instead of 3%. If I sell for $500, then the effective interest rate would be 6% instead of 3%. (In actuality, the new sale price is more complex because there is still the repayment of the full principal at the end to factor in, but example is for ELI5 purposes).
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