Bonds (10)

How risky are bonds? (3)

Iinterest Rate Risk

A bondholder is also exposed to interest rate risk if he sells his (or buys another's) bond before maturity.

Interest rates have an inverse effect on bond prices.

When

i) interest rates rise, outstanding bond prices fall and when

ii) interest rates fall, the bond prices rise.

Hence, short-term bonds will mature faster and be less affected by the movements in interest rates, but they pay lower returns.

Longer-term bonds will be subject to greater interest rate risk but pay higher returns.