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relationship Bonds an interest rate

Posted: Mon Feb 01, 2016 2:00 am
by boglechu
Suppose I bought $10000 of a bond index fund.

If feds increase interest rate to 0.5%, what will happen to my yield and the price of each share?
If feds decrease rate to 0%, what happens?
If feds decrease to -.25%, what happens?

Thanks.

Re: relationship Bonds an interest rate

Posted: Mon Feb 01, 2016 2:55 am
by Rx 4 investing
The Vanguard bond index fund is most likely to be more sensitive to the price movement of the benchmark 10-year treasury bond.

Vanguard Total Bond Market Index Fund Admiral Shares (VBTLX) has a “duration” of 5.8 years. The "rule- of- thumb" is that for every + / - 1% move in the benchmark rate, VBTLX will move + /- 5.8%.
If feds increase interest rate to 0.5%, what will happen to my yield and the price of each share?
The yield would move up +0.5% with the benchmark rate, and the principle amount of $10,000 would decrease 2.9% to $9,710. (10,000 x 0.029 = $290; 10,000 – 290 = 9,710)
If feds decrease rate to 0%, what happens?
The yield on your fund would remain relatively stable near the current rate. Your principle amount of $10,000 would remain relatively stable also, but may fluctuate mildly with periodic bond market developments. And if you reinvest the monthly dividends, your principle amount would increase slowly by the amount of the monthly payouts.
If feds decrease to -0.25%, what happens?
The yield on your index fund would likely drop -0.25% along with the downward move in the yield on the benchmark bond, but your principle amount would increase +1.45% to $10, 145 . (10,000 x 0.0145 = $145; 10,000 + 145 = 10, 145).

Referring back to the “duration” of this fund of 5.8 years, you would not have to worry as much about increases in interest rates if you would buy and hold the fund for that time period. You can read more about “the point of indifference” in the Wiki library here:

viewtopic.php?t=120947

Hope this helps.

Re: relationship Bonds an interest rate

Posted: Mon Feb 01, 2016 4:02 pm
by Phineas J. Whoopee
boglechu wrote:Suppose I bought $10000 of a bond index fund.

If feds increase interest rate to 0.5%, what will happen to my yield and the price of each share?
If feds decrease rate to 0%, what happens?
If feds decrease to -.25%, what happens?

Thanks.
The Fed only controls the shortest of short term rates at which banks lend to each other. Here's a post about it I wrote today. It explains why there isn't such a direct relationship as your question seems to imply.

Auctions, not the Fed, set 10 year bond yields, so I question the relevance of Rx's answer.

PJW

Re: relationship Bonds an interest rate

Posted: Mon Feb 01, 2016 6:04 pm
by jimkinny
boglechu wrote:Suppose I bought $10000 of a bond index fund.

If feds increase interest rate to 0.5%, what will happen to my yield and the price of each share?
If feds decrease rate to 0%, what happens?
If feds decrease to -.25%, what happens?

Thanks.
Maybe nothing will happen. this stuff is market driven for the most part and it also depends in part on the markets expectation of future interest rates and inflation expectations over days to 30 years, depending upon the term of the bond(s).

Re: relationship Bonds an interest rate

Posted: Mon Feb 01, 2016 6:20 pm
by RyeWhiskey
boglechu wrote:Suppose I bought $10000 of a bond index fund.

If feds increase interest rate to 0.5%, what will happen to my yield and the price of each share?
If feds decrease rate to 0%, what happens?
If feds decrease to -.25%, what happens?

Thanks.
It seems as though you need to research the relationship between bond prices and interest rates. There is ample information available with a simple search but, in the effort of simplicity, if rates rise the price of bonds should decrease according to their duration. Conversely, if rates fall the price of bonds should rise according to their duration. This means that longer duration bonds are more sensitive to interest rate changes than short term bonds.

It also underscores that bonds should be held in relation to equities, that is to say that their purpose is to ballast the larger swings of equity prices over the long run. If one is concerned about 0.5% interest rate movements, one ought to reconsider one's risk tolerance as a whole. :beer