Why Does the Price of a Bond Change?
According to the United States Securities and Exchange Commission (SEC), a bond is a debt instrument. This type of security is much like an IOU. Investors who purchase bonds are loaning money to the issuer in return for a promise to repay the loan plus interest. While the face amount of the bond and its interest rate may be fixed, the price of the bond, once issued, may fluctuate to reflect current market conditions.
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Types
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Investors may purchase a wide variety of bonds. According to the SEC, bonds may be issued by the U.S. government and its agencies, state and local municipalities, corporations and foreign governments. Bonds issued by the U.S. government are considered safe, while bonds issued by corporations may be safe or risky, depending on the financial status of the issuing corporation. The price of the bonds may change based on the perceived risk factor associated with the issuing entity.
Features
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Bonds may come in registered or bearer form. Owners of registered bonds are recorded in the issuer's files and interest payments are sent directly to the registered owner. Bearer bonds have coupons affixed to the bond. The bearer of the bond takes the coupon to a paying agent, typically a national bank, to receive interest payments. The face amount of the bond is paid to either the registered owner or bearer upon the bond's maturity. There is little difference in price fluctuation based on whether a bond is registered or bearer.
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Time Frame
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Bonds are issued with a variety of maturity dates. The longer the expiration date, the greater the risk and the higher the interest rate paid by the bond issuer is likely to be. Once the bond has been issued, it may be traded on the open market like any other security. The price of the bond will be determined in part by the amount of time left until the bond matures.
Interest Rate
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Bonds which are traded on the open market are quite sensitive to changes in the prevailing interest rate. If the prevailing interest rate rises above the fixed interest rate attached to the bond, the price of the bond on the open market will decline to make it more competitive. If the prevailing interest rate declines below the fixed rate attached to the bond, the price of the bond will rise to compensate.
Market Conditions
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Bond prices on the open market may fluctuate because of positive or adverse news regarding the issuing entity. Negative or positive news regarding the economy as a whole may also influence the price of bonds. Many municipal and corporate bonds are rated for stability and safety by professional rating companies such as Moody's or Standard & Poor's. According to the Financial Industry Regulatory Authority, if an issuing entity's credit rating drops or improves, the price of the bond will typically respond in tandem.
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References
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