Question

You own a bond that has a duration of 6 years. Interest rates are currently 7%, but you believe the Fed is about to increase interest rates by 25 basis points. How will this affect the price of your bond?

Answer 1

It can be said that when there is an increase in the interest rate by the Federal Reserve,there would be decrease in the bond prices because of the inverse relationship between Bond prices and interest rates.

there is always an inverse relationship between the bond prices and interest rates because when there would be increase in the interest rates, the capability of the bond holder will reduce in terms of disposable income going lower and it would mean that the bond prices will also be going lower.

The bonds who will be having higher duration will also be affected more by the interest rate changes because these bonds have a longer duration and they are more exposed to the change in the interest rates so the bond price will be decreasing and the bond is more vulnerable to the changes of the interest rates due to higher maturity period.