The Effect on Treasury Bonds When the Interest Rate Is Raised

When interest rates rise, bond prices drop.

When interest rates rise, bond prices drop.

One of the safest investments is a U.S. Treasury bond. The federal government issues bonds through its Treasury Department to pay for its operations when the money it receives from collecting taxes and from other sources doesn't cover its expenses. When you buy these bonds, you are lending money to the government. It promises to repay you the full amount at the maturity date of the bond, and it pays you a fixed rate of interest. You can sell the bond at any time before the maturity date, but its value will vary, depending on the prevailing interest rates in the market.

Interest Rates

A Treasury bond has a fixed interest rate applied to a fixed face value. The interest rate is called the coupon rate, and the Treasury pays you the interest every six months. For a bond with a face value of $1,000 and a coupon rate of 5 percent, the bond pays $25 every six months. The interest rates in the wider economy are constantly changing. They depend on supply and demand, economic conditions and investors' perception of risk. These general interest rates can therefore be higher or lower than the Treasury bond interest rate at various times.


Since the interest rate the Treasury bond pays is fixed, the value of the bond fluctuates depending on whether you can get a better rate elsewhere. If the bond from Section 1 matures in 10 years, you will get $25 every six months and $1,000 in 10 years. If market interest rates go up, you'll be able to invest $1,000 for 10 years elsewhere, such as in corporate or municipal bonds, and get a better rate. Your $1,000 might pay you $40 every six months at a rate of 8 percent. This means that the Treasury bonds are worth less than when interest rates were lower. If rates drop, the Treasury bond value goes up again.


While market interest rates affect the value of Treasury bonds, the actual price depends on how many investors want to buy them. When interest rates go up, investors put their money elsewhere and don't buy as many Treasury bonds. As a result, demand and prices go down. When interest rates go down, Treasury bonds become more attractive, more investors want to buy them, and demand and prices rise. Other factors may influence the prices of the bonds. When investors think there is a risk that other investments will not pay back the principal, they buy more Treasury bonds since they are low-risk. In such a case, Treasury prices may be high even when other investments pay more interest.

Buying and Selling

You can buy Treasury bonds directly from the Treasury at regular auctions, or you can buy and sell them through a broker. Buying directly from the Treasury is free, but you can't sell them back. A broker will charge a commission for arranging the purchase or sale. When you own Treasury bonds and their value drops as the interest rates rise, you may want to sell them and get a better return for your money. A broker can sell them for you and invest the money at higher interest rates. He can also invest more of your money in Treasury bonds if you want to lower your risk and accept a lower rate. How you invest in Treasury bonds depends on your personal financial situation, your tolerance for risk and your goals.


About the Author

Bert Markgraf is a freelance writer with a strong science and engineering background. He started writing technical papers while working as an engineer in the 1980s. More recently, after starting his own business in IT, he helped organize an online community for which he wrote and edited articles as managing editor, business and economics. He holds a Bachelor of Science degree from McGill University.

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