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Author: foobar73 Big red star, 1000 posts Feste Award Nominee! Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 35400  
Subject: Re: Should One Be In Bonds Now? Date: 6/21/2002 3:47 PM
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I'm considering buying an individual bond issue for the first time. Is there a way of figuring the proportional effect of general interest rate changes (eg. T-Notes) on the price of my individual bond? If I wanted to sell prior to maturity during rising interest rates is it just a given that the price will be less, but no way to know how much less relative to the general increase in interest rates? (Assuming no change in the rating of the issuer.)

The change in price of a bond should almost exactly be that which will cause the bond's yield to be the new underlying interest rate. For instance, if one buys a bond which yields 5% at a certain price, and rates drop to 4%, the new price of the bond would be such that a buyer would yield 4% for that bond.

Unfortunately, yield is a not-so-straightforward calculation involving both the maturity and coupon rate, so it is not so easy to figure out what the change in price will be. The main exception is for zero coupon or strip bonds, which have no coupon. As a rule of thumb, you can multiply the maturity of the bond (in years) by the change in interest rate to estimate the change in price. For instance, a 5-year zero coupon bond will drop approximately 5% in price, should the applicable interest rate rise by 1%.

Extending from this, the higher the coupon, the lower the volatility. If the example 5-year issue paid a coupon, its price would drop much less than 5% for an interest rate rise of 1%.

A bond's "duration" can be used to estimate its volatility due to interest rate changes. You can multiply the duration (in years) by the change in interest rates to get an estimate of the change in price. A bond with duration of 3 years, for instance, would be expected to have a price change of 3% if interest rates changed by 1%. Not coincidentally, the duration of a zero coupon bond is exactly its maturity. You can probably find a duration calculator for bonds on the web; your broker might also be able to quote you the duration for a given bond as well.
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