Understanding Yield & the Effects of Rising Interest Rates
Think of yield as the return provided by a fixed-income
investment. The yield on a bond is based on both the
purchase price of the bond and the interest (or coupon)
payments received each year. Yield is calculated by
dividing the bond’s annual interest payment (the
coupon) by its purchase price. Yield is often the term
used to describe long-term interest rates.
Why Rising Interest Rates (and Yields) Push Down
Bond Prices
Interest rates and bond prices have an inverse relationship.
When interest rates fall, bond prices usually rise
and when interest rates rise, bond prices usually
fall.
Example: An investor buys a new bond for $1,000 that
has a 6% interest payment (yield) earning $60 in interest
each year (this interest payment is generally referred
to as the “coupon”). If interest rates
increase by 1%, new bonds will provide a 7% interest
payment, paying investors $70 annually. Because investors
are now able to buy a bond with a higher interest payment
(higher yield), not as many people will want to buy
the 6% bonds. This decline in demand causes the value
of the 6% bond to fall.
The key point is that a bond’s yield will rise when
the value of the bond declines.
So when bond yields (or interest rates) are rising,
it actually means that the value of bonds in general
is declining. This is why rising bond yields are generally
considered to be undesirable for existing bond investors.
Talk to your advisor about how changing interest rates
impact your portfolio. Your advisor can help you determine
appropriate investment solutions for your portfolio
in the current environment.
To learn about individual RBC Funds and how they can
address your investment objectives, access our Fund
Updates. If you are ready to invest now, contact
your advisor or explore the options
available to invest with RBC Financial Group.
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