# Exchange rate and interest relationship with bonds

### How Bond Yields Affect Currency Movements - omarcafini.info

The same is true with the relationship between currencies and bond To see how interest rates have played a role in dictating currency, we. Interest rates and bond prices have an inverse relationship; so when one goes up, the other goes down. The question is: How does the prevailing market interest. Professor Krugman has a new post that tries to explain why nominal US sovereign interest rates are higher than nominal euro area bond yields.

Though the ups and downs of the bond market are not usually as dramatic as the movements of the stock market, they can still have a significant impact on your overall return.

They move in opposite directions, much like a seesaw. The opposite is true as well: When bond prices rise, yields in general fall, and vice versa.

What moves the seesaw? However, other factors have an impact on all bonds. A rise in either interest rates or the inflation rate will tend to cause bond prices to drop. Inflation and interest rates behave similarly to bond yields, moving in the opposite direction from bond prices. If inflation means higher prices, why do bond prices drop? The answer has to do with the relative value of the interest that a specific bond pays. Rising prices over time reduce the purchasing power of each interest payment a bond makes.

Why watch the Fed? Inflation also affects interest rates. The Fed takes an active role in trying to prevent inflation from spiraling out of control. When the Fed gets concerned that the rate of inflation is rising, it may decide to raise interest rates.

**How rising interest rates may impact bonds**

To try to slow the economy by making it more expensive to borrow money. For example, when interest rates on mortgages go up, fewer people can afford to buy homes. That tends to dampen the housing market, which in turn can affect the economy.

When the Fed raises its target interest rate, other interest rates and bond yields typically rise as well. New bonds paying higher interest rates mean existing bonds with lower rates are less valuable. Prices of existing bonds fall. An overheated economy can lead to inflation, and investors begin to worry that the Fed may have to raise interest rates, which would hurt bond prices even though yields are higher.

Now, let's say the opposite happens. Let's say that interest rates go down. Let's say that we're in a situation where interest rates, interest rates go down.

So how much could you sell this bond for? I'm not being precise with the math.

I really just want to give you the gist of it. So now, I would pay more than par. Or, you would say that this bond is trading at a premium, a premium to par.

## Bonds, Interest Rates and the Impact of Inflation

So at least in the gut sense, when interest rates went up, people expect more from the bond. This bond isn't giving more, so the price will go down. Likewise, if interest rates go down, this bond is getting more than what people's expectations are, so people are willing to pay more for that bond.

Now let's actually do it with an actual, let's actually do the math to figure out the actual price that someone, a rational person would be willing to pay for a bond given what happens to interest rates.

And to do this, I'm going to do what's called a zero-coupon bond. I'm going to show you zero-coupon bond. Actually, the math is much simpler on this because you don't have to do it for all of the different coupons. You just have to look at the final payment. There is no coupon. So if I were to draw a payout diagram, it would just look like this. This is one year. This is two years. Now let's say on day one, interest rates for a company like company A, this is company A's bonds, so this is starting off, so day one, day one.

The way to think about it is let's P in this I'm going to do a little bit of math now, but hopefully it won't be too bad. Let's say P is the price that someone is willing to pay for a bond. Let me just be very clear here.

- Relationship between bond prices and interest rates
- The Relationship Between Bonds and Interest Rates
- How Bond Yields Affect Currency Movements

If you do the math here, you get P times 1. So what is this number right here?

### Relationship between bond prices and interest rates (video) | Khan Academy

Let's get a calculator out. Let's get the calculator out. If we have 1, divided by 1. Now, what happens if the interest rate goes up, let's say, the very next day? And I'm not going to be very specific. I'm going to assume it's always two years out. It's one day less, but that's not going to change the math dramatically. Let's say it's the very next second that interest rates were to go up.

Let's say second one, so it doesn't affect our math in any dramatic way. Let's say interest rates go up.