Interest Rates: The Key To Understanding Bonds

Interest rates can be regarded as the cost a company must pay to borrow money and therefore it is affected by supply and demand.  When there is a lot of expansion in the economy there is a great deal of demand for money and often not enough supply of money to go around, so interest rates tend to rise.  In the reverse, during economic downturns fewer people need money and interest rates generally fall.  Bond yields reflect not only the current economic demand for money but estimated future demand as well.  Since a bond’s yield is fixed for a period of time (based on the bond’s life), this must be taken into consideration when the bonds are initially offered.  Also the bond yield will affect the long term price of the bonds based on the economy.