By Matthew Kerkhoff
If you own any bonds, or have exposure to bond funds, perhaps through a retirement account, it’s a good idea to understand how the value of those bonds will react to changes in interest rates.
Recall that owning bonds, or being a lender, entails two primary types of risk: default risk and interest rate risk. Default risk is the risk that the borrower will not be able to repay, leaving the lender out to dry. Interest rate risk is the risk that market interest rates will rise, reducing the value of existing bonds.
Most of us are well aware of the cardinal rule when it comes to bonds: rising interest rates drive bond prices lower, and falling interest rates drive bond prices higher. But how much is the price of your bond or bond fund likely to fall if interest rates rise 1%? Or 2%? What about 5%?
The answer lies in ... Log in or subscribe to continue reading.