Factors Affecting Bond Prices

Factors Affecting Bond Prices

While the face value and coupon of a bond remain stable, the bond’s market price on the secondary market can change constantly.

How interes rates affect bond prices

Prevailing interest rates have a significant effect on bond prices. As interest rates go up, the prices of bonds go down and vice versa. When a bond’s coupon falls below market interest rates, the bond price also falls as traders seek a consistent yield-to-maturity. When interest rates fall, some companies sell new bonds at the lower rate and then buy back their older, more expensive bonds with money from this sale.

When interest rates go up, new bond issues offer higher coupon rates than older bonds, decreasing the values of older bonds. When interest rates go down, new bonds give smaller coupon rates while older bonds earn interest at the previously higher rate, increasing their value.

Measuring the value of a bond

The value of a bond can be measured by its yield-to-maturity, which takes into account the difference between the bond’s face value and its market price. If a bond is bought at a discount or premium, its yield-to-maturity will be respectively higher or lower than its coupon rate.

Time to maturity affects price

The amount of time a bond has left until maturity also affects its price. The longer it takes a bond to mature, the more its price will fluctuate with changing interest rates. The prices of long-term bonds will fluctuate more than the prices of short-term bonds, with the prices moving in the direction opposite of interest rates.

Changes in credit ratings affect market prices

A change in a bond’s credit rating can also change the market price of a bond. A credit rating is an assessment of a bond issuer’s ability to pay back its bonds. The better a bond is rated, the lower its default risk. If a bond’s rating is lowered, its price will fall. If the rating improves, its price will rise.