Betty asked in Business & FinanceInvesting · 1 decade ago

Bonds: why do you buy high and sell at a low interest rate?

Why do people buy bonds at a high interest rate and sell they for a low interest rate to maximize profits. How does this work? Please explain.

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  • Anonymous
    1 decade ago
    Best Answer

    Because the interest rate of the bond and the par value are inversely related. If I buy a 10 year bond with a par value of $100 and a 5% coupon which is always stable and prevailing interest rates fall to 3% a year later, then the demand for my bond goes up because it has a higher coupon rate than the what the market offers, the result is that the value of my bond rises to $115.57. Therefore if I sell it in the open market at the going rate I have gained 20.57 in profit, the profit on the bond price increase from par and the $5 coupon for the one year I held it.

    Now consider the inverse situation, same bond, but a year later rates rise to 8%, now its harder to sell my bond at par when investors can get an 8% coupon in the market so the price of my bond falls to $81.26 making it more attractive to investors in the market, if I sell it in that environment I realize a loss of $13.74, the loss of 18.74 on the face value of the bond less the $5 coupon payment I received in year one.

    There is a great on line bond calculator that helps demonstrate the scenarios I showed above.

    http://www.smartmoney.com/Investing/Bonds/Bond-Cal...

  • _
    Lv 6
    1 decade ago

    Capital gains. The market price, the price people are willing to pay for a particular bond goes up when interest rates go down and goes down when interest rates go up. The reason is so the person buying the bond is effectively getting a current interest rate that will be different from that when the bond was first issued.

  • Anonymous
    1 decade ago

    When interest rates are high you need to "lock in" that high rate. To do that you need a fixed interest investment. Like a bond. A bond's interest rate will always be reflecting, apart from other factors like risk,current interest rates.As the interest rate falls 1. you will retain your high return and 2. the price of your bond will go up.

    With low interest rates the opposite is true.

  • 1 decade ago

    bond rates aka coupons don't really matter; it is the price of the bond that matters. For example wouldn't you be willing to pay more for something that gave you 40% vs. something that gave you 3%? That is where you have price difference.

    Source(s): I'm a bond trader
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  • Anonymous
    1 decade ago

    For most bonds, the interest rate ("coupon rate") is fixed. It's the market value of the bond that fluctuates.

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