A bond is a loan. The buyer lends a principal amount to an issuer — a government, an agency, or a company — which promises interest payments and repayment of principal on set dates.
Because those cash flows are fixed at issuance, the bond's market price moves to adjust for changes in what the market requires. That relationship is the foundation of everything below.
Price and yield move in opposite directions
When market interest rates rise, the yield a new bond must offer rises, which makes an existing bond paying a lower rate less attractive. Its price falls until its yield matches the market. When rates fall, the opposite happens.
This is not a market inefficiency; it is arithmetic. The bond's future cash flows have not changed, so the only way to change the return on buying it today is to change what it costs.
The practical consequence: a bond held to maturity returns its stated yield if the issuer pays. A bond sold before maturity returns whatever the market price happens to be.
Duration: sensitivity to rates
Duration estimates how much a bond's price changes for a given change in interest rates. A duration of five years means the price is expected to move roughly 5% in the opposite direction for each 1 percentage point change in yield.
Three things to know about it:
- Duration generally increases with maturity — a longer-dated bond has more future cash flows exposed to the changed rate.
- Duration is usually lower for higher-coupon bonds, because more of the return arrives sooner.
- Duration applies to portfolios, not just single bonds, and is a first approximation: the relationship is not perfectly linear, and it is least accurate for large rate moves.
Duration is the single most useful number for understanding interest-rate risk. "Short duration" means less sensitivity; "long duration" means more.
Credit risk is a different axis
A bond can lose money for reasons unrelated to rates: the issuer may fail to pay.
- Government bonds from stable issuers carry the least credit risk, though not zero.
- Investment-grade corporate bonds carry modest credit risk.
- High-yield bonds pay more precisely because default is more likely.
Credit risk has no fixed relationship to maturity. A one-year bond from a struggling issuer can be far riskier than a ten-year government bond.
The two risks are managed separately, and they can move independently. Credit spreads — the extra yield demanded for taking credit risk — typically widen in recessions and tighten in expansions. Rising rates can hurt bond prices even while the economy is strong; widening credit spreads hurt them because the outlook is deteriorating.
What this means for a portfolio
- Fixed income usually does more than one job. It can provide income, dampen the volatility of an equity-heavy portfolio, or hold liquidity. A holding can serve one of those roles without serving the others, and the right instrument differs by role.
- Rising rates are not straightforwardly bad for a bond investor who is reinvesting income — new purchases get higher yields. They are bad for someone who needs to sell.
- Liquidity in bond markets is different from equities. Many corporate bonds trade infrequently, and the price quoted is not always a price at which size could actually be transacted.
Eonvera's research covers bonds and other fixed-income instruments alongside equities, commodities, and digital assets, because the rate cycle transmits across all of them.