>> There are some important relationships between bond,
bond prices, and interest rates.
These relationships impact a bondholder's willingness to purchase and hold bonds,
as well as the price companies issue bonds for.
The first relationship is
the inverse relationship between interest rates and bond prices.
As interest rates increase,
the value of bonds decrease.
You can see on the graph,
if you start at the lowest interest rate and move right,
the price of the bond drops as rates increase.
The opposite is also true.
If you start on the far right and move left,
the price of the bonds increase as rates decrease.
This occurs because bonds stated rates are fixed.
So as market interest rates change,
the price of the bond will change.
The reason leads us to the next relationship.
The second relationship is how the stated and market interest rates impact bond prices.
The price of the bond will be less than
the face value if the market rate is above the stated rate.
You might have learned this relationship in an accounting class.
When the stated rate is greater than the market rate,
meaning that this bond pays more than other bonds,
the bond will sell at a premium because everyone wants to buy this bond.
Recall that a premium means greater than the face value.
When the rates are equal,
the bond sells for its face value.
Finally, when the stated rate is less than the market rate,
no one wants to buy the bonds.
So the price will be lowered to attract buyers.
This is called a discount.
The third relationship is that long-term bonds
have greater interest rate risk than do short-term bonds.
So changes in interest rates more dramatically
impact the price of long-term bonds rather than short-term bonds.
You can see that in the graph,
the pink line shows a long-term 30-year bond.
As interest rates move from left to right and increase,
the bond prices drop dramatically.
Conversely, the blue line is a short-term one-year bond.
As the interest rates change and move left to right,
the bond price slightly decreases.
So bonds with long maturities are impacted with changes in interest rates,
more so than bonds with short maturities.
So finally, let's conclude with some risks that impact bond prices.
As mentioned earlier, when interest rates rise,
bond prices will fall.
Default risk is the risk of loss or reduction in repayment due to bankruptcy.
The longer a bond is to maturity,
the greater the default risk.
Call risk, which we learned about earlier,
is the risk that a company will call and pay off the bonds early.
The reason this is a risk is that bondholders want regular income from bonds.
When they are paid off early,
they then need to search for different bonds to buy.
Usually, bonds with lower interest rates because
lower interest rates are what causes a company to call bonds in the first place.
Let me conclude with an example;
if you buy a 30-year corporate bond and it pays interest at 10 percent,
you'll have a very nice return.
Assume that after 10 years,
the market rates have dropped to five percent and the company is calling them.
You'll get your money back,
but now the new bond investment you find will likely be at five percent.
This is why call risk is a problem for bond holders.