The bond bet
Date posted: July 14, 2011
Although they perhaps aren’t as flashy as stocks, bonds are a very important key investment. A few weeks ago, a major fund investor controlling billions of dollars said he was selling all of his bonds because he thought interest rates were going to rise. N.C. State University economist Mike Walden considers whether the investor’s bet has paid off.
“Well, first a little background here … in terms of how you can make or lose money on bonds. Bonds carry a fixed interest rate, which means if you’re a holder of a bond with a fixed interest rate, you want the interest rate on new bonds to go down, because that makes your bond now that carries this higher rate more valuable. You’ll be able to sell it for more. So, you can actually make big money on bonds if you buy at the right time before interest rates go down.
“Now … this major bond investor in the country said, ‘Aha.’ He thinks that looking at the economic landscape with all the borrowing the Federal Reserve is doing and inflation fears that interest rates are going to go up, and so it made news when he said, ‘Hey, we’re going to sell all our bonds because we think rates are going up. And of course in that case, you would want to get out of bonds because if new bonds pay a higher rate than your bond, you’re only going to be able to sell your bond for a loss.
“Well, unfortunately for this big mutual fund investor, he was wrong. In fact, since he said what he said, interest rates have actually gone down. So people who’ve held bonds over the last month or two have actually made money.
“Now no assurance this will continue into the future, but I think the lesson here is, number one, bonds are an investment in which you can make or lose money. And, number two, even if you’re a really smart person, knowing where interest rates is going can be very, very difficult.”
Category: Economic Perspective