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© 2023 SEI 2 Conversely, if prevailing interest rates decline, say to 1%, then Bank A's existing bond paying 2% will return more to the bondholder than a newly issued bond (paying 1%). After all, if prevailing rates suggest that a $100 investment should only pay out 1%, an investment that pays out 2% should be worth more. This would also be reflected in the bond's price and the bond will trade at a premium (more than $100) 3 . Bonds in the real world The above example is for illustrative purposes only and does not capture the full breadth of factors which influence the wide range of debt securities. The intent is to illustrate the inverse relationship between bond prices and interest rates. Indeed, in the real world it is near impossible to consider changes to interest rates without also discussing how such changes affect fixed income markets. Bond holders may pay close attention to the U.S. Federal Reserve's (the Fed) monetary policy, and in particular, its stance on interest rates. The Fed may choose to raise interest rates to combat price inflation or lower interest rates to stimulate the economy. Changes in interest rates represent a risk to bonds as fluctuations can either increase or decrease the value of a bond. Indeed, longer term bonds are more exposed to interest rate risk as there is more opportunity (meaning, time) for interest rates to move adversely against the bond holder. Nevertheless, while bonds, like all securities, carry some form of risk, they can also be an effective tool to help diversify your investment portfolio. See SEI's related pieces on Diversification and Bonds 101 for more information. Important information Information provided by SEI Investments Management Corporation (SIMC). This information is for educational purposes only and should not be relied upon by the reader as research or investment advice. Investing involves risk, including possible loss of principal. Bonds and bond funds will decrease in value as interest rates rise. Diversification may not protect against market risk. 3 $109.47. In Excel, PV=0.01,10,-2,-100)