What Happens to Bonds When Interest Rates Go Up?

Bond Interest Payments

When interest rates increase, the increase will not effect the interest payments being received by a bond investor. The majority of bonds pay a fixed rate of interest called, the coupon rate, and the interest is paid in two semi-annual payments. For example, an investor owns a $100,000 corporate bond with a 6 percent coupon rate. The bond will pay $3,000 in interest to the investor twice a year. Changing market interest rates will not affect the amount of interest the investor receives from a bond in his portfolio.

Rising interest rates will impact the market price of bonds. Bond prices move inversely to interest rates, so increasing rates result in declining bond prices. Using the 6 percent coupon bond, for example, if rates for comparable bonds go up to 8 percent, an investor would not pay full price for a bond paying only 6 percent. The price of the bond would have to decline to the point the 6 percent coupon resulted in an 8 percent yield to an investor.

The longer the time period until a bond matures, the greater the price decline from rising interest rates. For a short-term bond, the principal value will be repaid soon, when the bond matures. This fact will keep the bond market price near the principal value. For a long-term bond, it can be many years before an investor receives the principal value. To sell a long-term bond with a low-coupon rate, the price will be significantly lower than the face amount.

An investor expecting higher interest rates can protect the value of her portfolio by selling longer term bonds and buying short-term securities. If the timing in interest rate changes is uncertain, a laddered bond portfolio, holding bonds with maturities staggered every year or two, will allow flexibility for any interest rate changes. As shorter term bonds mature the proceeds are reinvested in longer term bonds, usually at higher interest rates. Bonds will move down the ladder as time passes, always providing matured securities to be reinvested on a longer term basis.