Trouble With the (Yield) Curve
Because interest rates do not always move in tandem, investors need to pay close attention to the yield curve and spreads to gauge risk.
For more than a year, the term "interest rate" has struck fear among bond investors. These fears intensified recently after Federal Reserve comments sparked speculation that the Fed will begin to increase the federal-funds rate early next year. After all, as interest rates rise, most bond prices decline.
Investors often use duration to estimate a bond's interest-rate sensitivity. It approximates the change in a bond's price for an incremental interest-rate change. For example, a bond with a duration of five years might lose 5% of its value for a 1% increase in interest rates. However, this approximation is only accurate for small and parallel changes in interest rates across the yield curve.
Thomas Boccellari does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.