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How Interest Rates Affect Bonds
How Interest Rates Affect Bonds
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Fixed income portfolio managers may each have their own distinct
investment approach, but if there’s one factor they all scrutinise, it’s
interest rates. Why? Here’s a look at the relationship between interest
rates and bonds, and how portfolio managers protect investors from
interest-rate risk.
Inflation expectations
Apart from interest rates, portfolio managers also pay close attention to
inflation expectations. Often called the ‘enemy of the bond investor’, rising
inflation erodes the value of bonds and makes their coupon payments less
appealing, if interest rates remain constant or rise.
In bond markets, inflation expectations are measured by the difference in
yield between an inflation-linked bond (whose value rises and falls in line
with inflation) and a regular, or nominal, bond of the same maturity. This is
called the ‘breakeven’ rate and allows managers to gauge inflation
expectations in the market and position their portfolios accordingly.