Interest Rate Risk

The prices of bonds fluctuate with changes in interest rates, giving rise to
Interest rate risk
.

Bond Theorems
1.Bond prices are negatively related to interest rate movements.

As interest rates decline, the prices of bonds rise; and as interest rates rise, the
prices of bonds decline.

2.For a given change in interest rates, the prices of long-term bonds will
change more than the prices of short-term bonds.

Long-term bonds have greater price volatility than short-term bonds.

All other things being equal, long-term bonds are more risky than short-term
bonds.
Interest rate risk increases as maturity increases, but at a decreasing rate.

3.For a given change in interest rates, the prices of lower-coupon bonds

change more than the prices of higher-coupon bonds.

The lower a bonds coupon rate, the greater its price volatility, andhence, lower
coupon bonds have greater interest rate risk.
The lower the bonds coupon rate, the greater the proportion of the bonds cash
flow investors will receive at maturity.

All other things being equal, a given change in the interest rates willhave a greater
impact on the price of a low-coupon bond than a higher-coupon bond with the same
maturity

Bond Theorem Applications:

If rates are expected to increase, a portfolio manager should avoid investing

inlong-term securities. The portfolio could see a significant decline in value.
If you are an investor and you expect interest rates to decline, you may wellwant
to invest in long-term zero coupon bonds. As interest rates decline, the price of
long-term zero coupon bonds will increase more than that of any other type of bond