The price and rate seesaw
A bond’s price is really the answer to one question: what are the future coupons and face value worth today? To find that “today’s value”, future money is shrunk back using the current market interest rate, which is called discounting. The higher the rate, the less each future taka is worth today, so the lower the bond’s price.
Seen another way: the bond’s coupon is fixed, but a new buyer wants a return equal to the market. When rates rise, an older bond’s price has to fall just enough for the buyer’s yield to match the new rate. When rates fall, the opposite happens and older, higher-coupon bonds rise in price.
Say Tania holds a 10-year bond with a 10% coupon. Suddenly new bonds are paying 12%. At the same time her brother holds a 10% bond with only 2 years left. Both bonds will fall in price, but hers far more, because she must carry the “low-coupon penalty” for ten years and he for only two. The numbers are only an example.
When rates fall, the opposite happens: existing bond prices rise.
Why it matters to an investor
- To size the risk in advance: knowing the duration lets you estimate roughly what percentage a bond could lose if rates rise by 1%.
- To match maturity with need: money you may need soon, if held in long bonds, may have to be sold cheaply when rates have risen.
- To understand bond funds: a fund has no fixed maturity, so a fall in unit prices when rates rise cannot be avoided by “holding to maturity”.
- To see the risk even in government bonds: default risk may be low, but every bond carries price risk from interest rates.
Duration: rate sensitivity in one number
Duration measures how sensitive a bond’s price is to interest rates. The rule of thumb: for each 1 percentage-point change in rates, the price moves in the opposite direction by roughly the duration as a percentage. With a duration of 10, a 1% rise in rates cuts the price by about 10%, and a 1% fall raises it by about 10%.
You can think of duration as “on average, how many years until your money comes back”. A bond whose money mostly arrives far off, at the end, has a high duration. So a zero-coupon bond’s duration is about equal to its maturity, while a bond that pays coupons has a duration shorter than its maturity.
- The longer the maturity, the higher the duration and the bigger the price swings.
- The lower the coupon, the higher the duration, because more of the money comes at the end.
Limits of the rule, and the other side
Bangladesh has seen a real example of this. In 2021, auction yields on long-term government bonds were around 6–7%, and in March 2025 the 10-year yield passed 12%. Anyone wanting to sell a low-coupon long bond from 2021 midway would have faced a large fall in price.
- The duration rule works well for small changes. For big changes, prices rise a little more than the rule says when rates fall, and fall a little less when rates rise.
- Hold to maturity and, if the issuer pays as promised, you receive the full face value and every coupon. Price falls along the way then stay on paper.
- There is a flip-side risk too: when rates fall, bond prices rise, but the coupons and maturing money you receive must be reinvested at lower rates. This is called reinvestment risk.
- Not only the general rate: if confidence in an issuer drops, buyers demand extra yield on its bonds, and that also pushes the price down.
Worked example
- Say three bonds, each with a face value of Tk 1,00,000, a 10% coupon (paid once a year) and market rates at 10%, so each is priced at Tk 1,00,000. Years left: 2, 5 and 10.
- If rates rise to 12%, the prices become about Tk 96,600 (−3.4%), Tk 92,800 (−7.2%) and Tk 88,700 (−11.3%).
- If rates fall to 8%, the prices become about Tk 1,03,600 (+3.6%), Tk 1,08,000 (+8.0%) and Tk 1,13,400 (+13.4%). The 10-year bond’s duration is about 6, so a 1% move in rates moves its price by about 6%.
Result: the longer the maturity, the more the price moves for the same change in rates; and prices rise a little more when rates fall than they drop when rates rise. The numbers are only an example, with tax left out.
See the numbers as a table
| If rates rise to 12% | If rates fall to 8% | |
|---|---|---|
| 2 years left | -3.4% | 3.6% |
| 5 years left | -7.2% | 8% |
| 10 years left | -11.3% | 13.4% |
Common mistakes
- Treating maturity and duration as the same. A coupon-paying bond’s duration is shorter than its maturity, and longer if the coupon is low.
- Putting money you may need soon into long bonds, then being forced to sell cheaply after rates rise.
- Treating long bonds bought in the hope of falling rates as a sure profit. Nobody knows for certain which way rates will go.
- Thinking a bond fund’s price risk disappears if you just hold it to maturity. A fund has no fixed maturity.
Rates and bond prices move in opposite directions, and duration tells you how far: roughly, a 1% change in rates moves the price by the duration in percent. Longer maturities and lower coupons mean bigger swings.