Bonds and Interest rates

In this article we will see how:

Bond value goes Down, When Interest rate goes UP ; &
Bond value goes UP, When Interest rate goes DOWN. 

Kindly click here to read terminologies used in bond market

The big deal Illustration :

Let’s say My co. want money for further business activities. This time not as a loan from bank, but directly from the public. My company XYZ issues bonds having principle of 1000 rs each, with a coupon rate of 5%
Mohan, a guy who purchased it, receives annually 50 rs as interest till the bond matures, after mature date he will receive his 1000 rs back.
Now another co. say Hadoomba ltd. comes out with bond of same 1000 rs but provide interest rate of 8%. Mohan, now want to get this new bond which will earn him more interest. Mohan buy hadoomba ltd. bond which will provide 80 rs annually and sell his earlier bond to sharekhan (or any broker), & the latter will try to find new customer for XYZ bonds.
To give same 50 rs yield to holder, my bonds will now be sold at 625 rs (i.e 375 rs less) {8% of 625 = rs 50}; hence xyz bonds are now selling at discount.

Kindly note many other factors also comes into scenario; like stability, risk factors, prospects etc of My company vs Mohan company
Another scenario: Let’s say interest rates goes down market to 3%
xyz bonds will now be selling at premium in market.
At what price ? 3% of x = 50 ; 3/100*x = 50 = 1666.66667 i.e 667 above face value.

In 1st scenario when interest rate increased, xyz started selling at cheaper than face value.
In 2nd scenario when interest rate decreased, xyz started selling at more than face value.

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