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Fixed Income

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What affects bond prices?

Bond prices are primarily affected by 2 factors:

The current interest rate- The price of a bond, and therefore the value of your investment fluctuates with changes in interest rates. For example, you buy a bond for Rs.1,000 that pays 5% interest. If you hold the bond until maturity, you get your Rs.1,000 back plus the 5% interest payments you've received from the issuer. However, between the time you bought the bond and the date it matures, the bond won't always be worth Rs.1,000. If interest rates rise, your bond is worth less than Rs.1 000. If interest rates fall, your bond is worth more than Rs.1,000.

The credit quality of the issuer- If the rating agencies change the credit rating of the issuer while you hold the bond, the value of your bond will be affected. If the credit rating declines, the value of your bond will also decline. However, if you hold the bond to maturity and the issuer doesn't default, you will get your entire Rs.1,000 back.

When the bonds are initially priced, the maturity also helps determine the price. Longer maturities tend to pay higher interest rates than shorter maturities. That's because your investment is exposed to interest-rate risk for a longer period of time.

Keywords

Fixed Income, Bonds

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