As hopefully all investors know, bond prices move in the opposite direction of interest rates. When rates fall, older bonds with their higher payments are worth more than new bonds.
Saturday, May 15th 2004, 11:08PM
by The Landlord
When rates rise, bond prices fall. The reason is simple: Yields on new bonds will be higher than those of older bonds, which won?t sell except at a discount.
For example, who wants to pay $1,000 for last year's bond paying $60 a year when the same $1,000 will buy a new one paying $75? In that environment, the older bond might sell for $800, leaving the seller with a $200 capital loss.
This is the environment we are in at present. As most of you now know, the Reserve Bank of New Zealand raised the official cash rate on Thursday by 0.25 per cent to 5.50 per cent.
After the bear market of 2000-2002, many investors realise they need bond funds in their portfolio to reduce risk. But many are skittish. A common question among bond investors is: "Given the current low interest rates, how do I purchase bond funds so that rising interest rates won?t have an adverse effect on my bond investments?"
