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I read in a study text that:

  • When interest rates are decreasing, investors will migrate their bonds from short- to longer-term ones
  • When interest rates are increasing, investors will migrate their bond holdings from longer-term to shorter ones

I don't fully understand why this would be, but I think this would have to be due to risk management and/or an attempt to take advantage of large movements in bond price.

Could anyone shed some light here to help me to understand what the relation between interest rates and bonds?

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  • Clarification please: What do you mean "interest rates are decreasing?". I take it mean an investor's expectations as to what way rates will go in future? And also, are you referring to government bonds (and to their targeted rates from their central bank?), or to some generic bond such as a corporate bond? – Aaron McDaid Dec 5 '11 at 22:58
  • @Aaron, apologies if I am not very clear, I am actually studying for the 2nd Level Japan Securities Dealers Association certification, in Japanese. My text has an all-too-brief, rote memorization on the relation of market interest rates and bonds. I take this bit that I need to memorize (but want to really understand) to be about bonds in general, both government and corporate. I am none too sure, but would there be an appreciable difference between the two types? – buruzaemon Dec 5 '11 at 23:18
  • I think I am being too pedantic. TomAu's answer is good. There is no appreciable difference between corporate and government bonds, for the purpose of this question. – Aaron McDaid Dec 5 '11 at 23:27
  • It is important to remember that bond yields do not change exogenously. Yields fall (prices rise) because demand increases. To cite current events, Treasury yields have fallen, but investors aren't necessarily switching to longer maturities. The yields falls because investors want these shorter-dated maturities. The key concept is that investors balance risk and return. – Richard Herron Dec 6 '11 at 2:27
  • @richardh, yes, I see that there are factors at work here such as the balance of risk and return, as well as the balance of supply and demand. Thanks for your comment, I feel like I am making headway in my learning. – buruzaemon Dec 6 '11 at 2:37
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If bond rates are falling, investors will want to buy longer-term bonds in order to LOCK IN today's (presumably) higher rate for as long as possible.

If bond rates are rising, investors will prefer to buy shorter-term bonds that can be ROLLED OVER at (presumably) higher rates later.

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    +1. But I'll expand a little: If the (implied) interest rate is expected to fall across the entire yield curve, then it makes sense to lock it in before it falls. However, short term interest rates do not always have to move in tandem with long term rates. You might be confident that a corporation or government will survive for two more years, but not for more than that. – Aaron McDaid Dec 5 '11 at 23:03

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