Interest rate rises

Having not owned bonds/Gilts through an interest rate raising cycle, what is the expected downward impact on bond/Gilt prices with raising interest? Interest rates are forecast to rise 0.5% by next May, though this could happen as early as this November. Presumably, just a 0.5% ride will not have a huge impact on bond/Gilt prices, especially since. What kind of changes in interest rate might produce what approximate downward impact on prices?

This may be of interest to some.
http://www.investopedia.com/articles/investing/052814/these-sectors-benefit-rising-interest-rates.asp

Comments

  • Depends on the particular bond, what should happen is that bonds with low yields and longer times to maturity will see greater increases in yields than bonds with higher yields and shorter times to maturity.
  • I quite like this article in Investopedia for calculating bond prices/yields in Excel:

    http://www.investopedia.com/articles/investing/051315/present-value-different-bond-types-using-excel.asp

    In general:

    + a bond with longer maturity is more sensitive to changes interest rates than a shorter term bond.
    + a bond with lower coupon rate is more sensitive to changes in interest rates than an higher coupon bond.

    Something not incorporated in the Excel formulae are the idiosyncratic factors. These are the issuer-specific variables, for example how the business model of the company will be impacted by a rate rise, the debt repayment profile of the issuer, etc.

    It is worth remembering after reading all the financial formulae… that the retail bonds we buy (usually) have positive convexity, which means that bond prices go up faster than they decrease.

    If and when a base rate increase comes about, it will be just 0.25% and the BoE may wait a some time before another increase. Given that it is unlikely rates will increase rapidly, price volatility is likely to remain lower than in historical periods when rates increased.

    I don’t expect a significant change in prices in the bonds I hold (apart from Enquest which is a different beast now) and I would not expect to change my mind about holding them to maturity at all. If anything, I will buy on a dip if yields match my risk/reward/horizon profile.
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