Trying to fully understand how Treasure Bonds value is diminished when federal interest rates rise.
In: 8
Lets say a bond pays 5%. If I buy a bond for 1000 dollars, I get 50 bucks in interest.
I can sell it for about 1,000 anytime. New bond paying 5%, my bond paying 5%. They are basically the same, so somebody buying a bond on the market would be happy to have either one.
Now let’s say interest rates rise to 7%. I can’t force the existing bond to pay more. But I can sell my bond at a lower price.
Lets say I sell it to you for 750.00. The bond still pays 5%, based on its original sale price of 1k, so it pays 50 dollars in interest.
Since you only paid 750, and you are getting 50 bucks, you are getting about 7%. You did this by agreeing to a lower sale price on the bond. If I won’t lower my price that much, nobody buys it. I’m free to hold my bond until maturity, unless you need the money right now (like for example, you are operating a bank, and there is a run on your bank)
(I’ve over simplifying many concepts to make it easier to understand. There is a lot more involved, like how long until the bond matures. So the actual math is a bit more complicated, but the concept is the same. I cannot force the bondholder to raise or lower interest, but I can raise or lower my sale price of the bond to give you similar interest rates.
The bond is a way for the government to borrow money from you at whatever interest rate they have established. As time passes, the bonds value grows according to the interest rate they establish, but you cannot cash it in with them until it has matured. That means a $100 30 year bond with a 1% interest rate is worth less than a $100 30 year bond with a 2% interest rate.
But if I have a $100 30 year bond thats 15 years old and has a 5% interest rate, it’s more valuable than a $100 30 year bond you can buy today at a 1% interest rate. So instead of buying one from the government, you can buy the one I have for a higher return, but I’ll charge you more than the government would. The low interest rate the government has increased the value of my bond.
Conversely, if I have 15 year old $100 30 year bond with a 1% interest rate, and the government is offering bonds at 5%, why would you buy a 1% bind from me when you can get a 5% bond from the government and will gain value faster.
The idea behind changing the interest rate isn’t always to give the government money, but rather to get money in or out of the economy. Since inflation is high, the government wants to raise interest rates so people buy bonds and that money is no longer circulating around the economy.
You bought a bond a year ago at 3% interest that you’re looking to sell. Interest rate is now 4%. If you want me to buy your bond at 3% instead of buying a 4% bond from the treasury you’d sell it to me at a discount to entice me
Lets say a bond pays 5%. If I buy a bond for 1000 dollars, I get 50 bucks in interest.
I can sell it for about 1,000 anytime. New bond paying 5%, my bond paying 5%. They are basically the same, so somebody buying a bond on the market would be happy to have either one.
Now let’s say interest rates rise to 7%. I can’t force the existing bond to pay more. But I can sell my bond at a lower price.
Lets say I sell it to you for 750.00. The bond still pays 5%, based on its original sale price of 1k, so it pays 50 dollars in interest.
Since you only paid 750, and you are getting 50 bucks, you are getting about 7%. You did this by agreeing to a lower sale price on the bond. If I won’t lower my price that much, nobody buys it. I’m free to hold my bond until maturity, unless you need the money right now (like for example, you are operating a bank, and there is a run on your bank)
(I’ve over simplifying many concepts to make it easier to understand. There is a lot more involved, like how long until the bond matures. So the actual math is a bit more complicated, but the concept is the same. I cannot force the bondholder to raise or lower interest, but I can raise or lower my sale price of the bond to give you similar interest rates.
You bought a bond a year ago at 3% interest that you’re looking to sell. Interest rate is now 4%. If you want me to buy your bond at 3% instead of buying a 4% bond from the treasury you’d sell it to me at a discount to entice me
Lets say a bond pays 5%. If I buy a bond for 1000 dollars, I get 50 bucks in interest.
I can sell it for about 1,000 anytime. New bond paying 5%, my bond paying 5%. They are basically the same, so somebody buying a bond on the market would be happy to have either one.
Now let’s say interest rates rise to 7%. I can’t force the existing bond to pay more. But I can sell my bond at a lower price.
Lets say I sell it to you for 750.00. The bond still pays 5%, based on its original sale price of 1k, so it pays 50 dollars in interest.
Since you only paid 750, and you are getting 50 bucks, you are getting about 7%. You did this by agreeing to a lower sale price on the bond. If I won’t lower my price that much, nobody buys it. I’m free to hold my bond until maturity, unless you need the money right now (like for example, you are operating a bank, and there is a run on your bank)
(I’ve over simplifying many concepts to make it easier to understand. There is a lot more involved, like how long until the bond matures. So the actual math is a bit more complicated, but the concept is the same. I cannot force the bondholder to raise or lower interest, but I can raise or lower my sale price of the bond to give you similar interest rates.
The bond is a way for the government to borrow money from you at whatever interest rate they have established. As time passes, the bonds value grows according to the interest rate they establish, but you cannot cash it in with them until it has matured. That means a $100 30 year bond with a 1% interest rate is worth less than a $100 30 year bond with a 2% interest rate.
But if I have a $100 30 year bond thats 15 years old and has a 5% interest rate, it’s more valuable than a $100 30 year bond you can buy today at a 1% interest rate. So instead of buying one from the government, you can buy the one I have for a higher return, but I’ll charge you more than the government would. The low interest rate the government has increased the value of my bond.
Conversely, if I have 15 year old $100 30 year bond with a 1% interest rate, and the government is offering bonds at 5%, why would you buy a 1% bind from me when you can get a 5% bond from the government and will gain value faster.
The idea behind changing the interest rate isn’t always to give the government money, but rather to get money in or out of the economy. Since inflation is high, the government wants to raise interest rates so people buy bonds and that money is no longer circulating around the economy.
The bond is a way for the government to borrow money from you at whatever interest rate they have established. As time passes, the bonds value grows according to the interest rate they establish, but you cannot cash it in with them until it has matured. That means a $100 30 year bond with a 1% interest rate is worth less than a $100 30 year bond with a 2% interest rate.
But if I have a $100 30 year bond thats 15 years old and has a 5% interest rate, it’s more valuable than a $100 30 year bond you can buy today at a 1% interest rate. So instead of buying one from the government, you can buy the one I have for a higher return, but I’ll charge you more than the government would. The low interest rate the government has increased the value of my bond.
Conversely, if I have 15 year old $100 30 year bond with a 1% interest rate, and the government is offering bonds at 5%, why would you buy a 1% bind from me when you can get a 5% bond from the government and will gain value faster.
The idea behind changing the interest rate isn’t always to give the government money, but rather to get money in or out of the economy. Since inflation is high, the government wants to raise interest rates so people buy bonds and that money is no longer circulating around the economy.
Bond prices move the opposite of interest rates. The bonds have different time frames when they mature. Overnight to 30 years.
So, higher bond prices,lower rates.
Lower bond prices,higher rates.
You bought a bond a year ago at 3% interest that you’re looking to sell. Interest rate is now 4%. If you want me to buy your bond at 3% instead of buying a 4% bond from the treasury you’d sell it to me at a discount to entice me
Latest Answers