Over a period of less than 3 weeks, the interest rates on the 30-year bond dropped from 3.47% to 3.25%. How does the value of the bond change? When interest rates drop, the value rises. But by how much?
Assume a face value of $1,000 and a nominal rate of 4.0% annually, with simple interest paid every 6 months, and the bond repaid after 30 years. At an interest rate of 4.0%, the present value is $1,000. At an interest rate of 3.47%, the present value is $1,098.32. At an interest rate of 3.25%, the present value is $1,143.04, an increase of about 4%.
As interest rates approach zero, the value increases almost exponentially. For example, if the effective interest rate drops to 1.0% on a 30-year 4% nominal bond, the value would increase to $1,775.88.
Are interest rates more likely to increase or decrease? If stocks are in a bubble, then investors might look for alternatives, and bid up bonds, decreasing interest rates. What if the stock market crashes? Investors might get spooked, and also shift money into bonds. Interest rates would increase only if investors are worried about inflation. So I think long-term interest rates will continue to decrease.
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