Thursday, May 19, 2016

Bond prices move opposite interest rates


Desperate for yield, investors are buying government bonds that come due further and further in the future. If you lend your money to the government, you expect to get it back. It’s not for nothing that British government bonds are ‘gilt-edged,’ and the U.S. Treasury yield is considered ‘risk-free’ in financial models. What could possibly go wrong?
Unfortunately, a lot. A small move in the yield on these increasingly popular 40-, 50- and sometimes even 100-year bonds can have a crippling effect on their capital value.
Anyone who might sell before they mature (hint: that’s everyone alive today for the longest-dated bonds), should consider how they'd feel if their supposedly safe bond had lost a quarter of its value in two months. It happened to the rock-solid German 30-year bund, just last year.
This calculator lets you play with interest rates and see just how big an impact changes to yield can have on the price of long-dated bonds. You might be surprised by how big the losses could be, if the drops in yield of the past couple of years go into reverse.

See how a rate hike of 1% results in 25% down in bond prices!