241) Factors Affect Bond Prices

241) Factors Affect Bond Prices

What are the Factors that affect Bond Prices?
There are many factors. Listed below are the main factors.

Main Factors:
1) Interest Rate
2) Inflation Rate
3) Bond Credit Rating
4) Bond Maturity Period
5) Currency Exchange Rate
6) Stock Market
7) Trader Strategy

1) Interest Rate

Investors will invest into investments that gives higher returns with lower risks. Bond Yields will compete with interest rates to attract investors. As bond pays fixed income, the bond price will change to change the bond yield.

When interest rate increases, bond yield also increases. This will cause bond price to drop.
When interest rate decreases, bond yield also decreases. This will cause bond price to rise.

For more info
http://highlevelrules.blogspot.com/2017/06/bond-price-moves-opposite-to-bond-yields.html

2) Inflation Rate

When inflation increases, bond prices fall. When inflation decreases, bond prices rise. Rising inflation erodes the purchasing power of the Future money Value. When the bond pays future coupon payments and maturity par value, the return on the investment will be worth less in today’s Present Value.

FV = PV(1+i)^n

PV = FV/(1+i)^n

FV = Future Value

PV = Present Value

i = Interest Rate

n = period

when Interest Rate (i) increases, Bond Present Value (PV) reduces

3) Bond Credit Rating

Bonds are being rated by Rating Agencies. Basically, Rating Agencies give credit rating from Highest grade (AAA) to lowest grade (D). Higher rating means lower risk. Lower rating means higher risk.

When the rating is higher, the risk of bond default is lower. When a bond defaults, the investor may not get back his coupon payments and invested capital.

For more info
https://en.wikipedia.org/wiki/Bond_credit_rating

4) Bond Maturity Period

As bond price is affected by inflation rate and interest rate, longer term bonds will face more uncertainties compared to shorter term bonds. Therefore, longer term bonds give better coupon payment as the additional risk premium. Longer term Bond will have higher price fluctuation as a result of the longer period it takes to mature.
Below is the "see-saw" concept on the maturity period effect on bond price movement when there is a change in interest rate.

5) Currency Exchange Rate

When foreigners buy another country's asset, their currency is converted into the local currency. A depreciation of the local currency will lower the total returns in the foreign currency. Conversely, an appreciation of the local currency will increase the total returns in the foreign currency.

Current Rate: 

RM1.00 = USD0.250

USD1.00 = RM4.00

Buy Investment

Depreciated local Currency: 

Worth Less (Lower) value in USD

RM1.00 = USD0.222

USD1.00 = RM4.50

Appreciated local Currency: 

Worth More (Higher) value in USD

RM1.00 = USD0.286

USD1.00 = RM3.50

When the local currency is depreciating, the foreigners may sell the assets to cut their losses.

6) Stock Market

Bond prices are affected by stock market by competing for the investors' money. Bonds are safer than stocks, but they offer a lower return.

Stocks do well when the economy is booming. As a result, when stocks go up in value, bonds value go down.

When the economy slows, consumers buy less, corporate profits fall, and stock prices decline. That's when investors prefer the regular interest payments guaranteed by bonds. This will create more demand for bonds and increase the bond prices.

7) Bond Trader Strategy

Bonds are traded in the bond market. When the bond prices had increased, bond traders will sell their bonds to take profits and invest into something else that had fallen in price. 

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https://highlevelrules.blogspot.com/2020/03/239-bond-specification-calculation.html

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http://highlevelrules.blogspot.com/2019/07/330-bond-market-vs-bond-fund.html

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http://highlevelrules.blogspot.com/2019/03/222-does-bond-fund-move-opposite-to.html

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