Bonds are considered investments that are characterized by having lower risks compared to stocks, as stocks are affected by interest rate risks – rising and falling asset or fund values in response to changes in prices.
Short, Intermediate, and Long-term Bonds
Short, intermediate, and long-term bonds are defined based on the maturity period of the bond. Bonds are essentially loans from investors to issuers. Issuers take money from investors, pay interest, and return the principal after the bond’s maturity period ends.
Relationship Between Yield and Risk
Understanding the risks of the bond market begins with recognizing that there is a different relationship between risk and yield compared to the relationship between average or total risk and yield. Risk and yield are simply related because investors demand greater compensation for higher risks. They will demand a higher yield when there is a high risk of interest rates, greater sensitivity to the issuer’s health, or when there are changes in economic outlook.
The Impact of Bond Maturity on Interest Rate Sensitivity
Any change in interest rates can affect the price of the bond. When interest rates rise, bond yields increase but their prices decrease. When interest rates fall, bond yields decrease but their prices rise. However, the extent of bond price movements depends on the maturity of the bond.
Historical Bond Fund Yields
If we look at the period between 2012 and 2021, we have seen multiple cycles of rising and falling interest rates. According to Morningstar analysis conducted by BlackRock, here’s how different types of bonds performed in different interest rate environments.
Bond Fund Yields for 2022
Typically, bonds and stocks move in opposite directions. However, 2022 was an exception. To combat high inflation, the U.S. Federal Reserve raised interest rates by 225 basis points between March and July 2022. This was catastrophic for bond fund yields.
Conclusion
Investors will not be able to reap the same benefits that they experienced from holding long-term bonds as they did from 2008 to 2019 if the bull market for bonds ends and prices continue to rise for an extended period. (The Federal Reserve has promised this.)
Frequently Asked Questions
What is the annual yield rate called when purchasing a bond in the open market?
How to calculate the yield rate for a bond?
Sources:
FINRA. “Bonds.”
FINRA. “Brush Up on Bonds: Interest Rate Hikes and Duration.”
BlackRock. “Prepare for lower bond returns,” Page 2.
Morningstar. “Morningstar Core Bond Index.”
Board of Governors of Federal Reserve System. “Policy Tools.”
Morningstar. “Why 2022 Has Been Such a Terrible Year for Bond Funds.”
Source: https://www.thebalancemoney.com/the-returns-of-short-intermediate-and-long-term-bonds-416970
Leave a Reply