InvestorQ : Does the price of long-term bonds versus short-term bonds is impacted by the changing interest rates?
Neha Samdani made post

Does the price of long-term bonds versus short-term bonds is impacted by the changing interest rates?

ramya Bhaskaran answered.
8 months ago
To understand this, it is pertinent to first understand the relationship between bonds and interest rates. The prices of bonds and interest rates are inversely proportional to each other. If the interest rates increase from the current level, the prices of fixed income securities decrease. Similarly, if the interest rates decrease, the prices of fixed-income securities increase. 

Simplifying this, when an investor invests in a bond, they lend money to the party issuing it in exchange for a fixed repayment at a later date along with guaranteed annual interest payments. The interest payment that is received periodically is known as coupon payment and the interest rate according to which the coupon payment is made, is called the coupon rate. 

Any change in repo rate affects the coupon rate. Let us assume that the present rate is 6% and bonds were issued at a coupon rate of 6.5%. Suppose RBI hikes the repo rate to 7.5%. An investor who is investing in the bond markets now would expect to receive a coupon rate of over 7.5% at the same price.  Thus, the value of the previously issued bonds at 6.5% decreases.  To make the old bonds attractive, the cost of these bonds with a lower coupon rate declines. Accordingly, bond prices fall when interest rates rise and vice versa. 

Long-term bonds are most sensitive to interest rate changes. There is a greater probability that interest rates will rise (and thus negatively affect a bond's market price) within a longer time period than within a shorter period. As a result, investors who buy long-term bonds but then attempt to sell them before maturity may be faced with a deeply discounted market price when they want to sell their bonds. With short-term bonds, this risk is not as significant because interest rates are less likely to substantially change in the short term. Short-term bonds are also easier to hold until maturity, thereby alleviating an investor's concern about the effect of interest rate-driven changes in the price of bonds.