Since the start of the year, the benchmark 10-year Treasury has risen about 20 basis points (1 basis point equals 0.01%) to 1.15% at this time of writing. The yield is still relatively low, but it is at the highest it’s been since last March.
The rapid rise in yield has fuelled concerns amongst bond investors. Typically when interest rates – and by extension, bond yields – rise, bond prices fall.
Here’s an example that illustrates this concept.
Let’s say you purchase a bond for $1,000 that matures in two years and pays a coupon of 2%. This means you will receive annual interest of $20, plus your original $1,000 investment back when the bond matures.
When interest rates go up, new bonds will be issued with the higher interest rate of say 3%. The “old” bond that pays 2% becomes less attractive to investors and they will not pay the “original” price of $1,000 for it. When this happens, the bond price falls and we say that the bond is trading at a discount.