David John MarottaDavid John Marotta is the President of Marotta Wealth Management, a fee-only financial planning and asset management firm in Charlottesville, Virginia. He is an oft-quoted writer and speaker on financial matters and his weekly financial column can be found at www.eMarotta.com
Host: Why do bond prices fluctuate?
David Marotta: Bond prices fluctuate based upon interest rate movements. So imagine you have a bond that's paying 8% interest and its a 20-year bond. So for 20 years its going to be paying 8% interest, and you hold the bond for 10 years and its still paying 8% interest. Now, its a 10-year bond that's paying 8% interest. But in the meantime, interest rates have moved. Imagine the interest rates are now paying 9%. So new bonds -- you can get a 10-year bond at 9%, you have this 10-year bond that's is only paying 8%. If you go to try to sell your bond, they are not going to give you the face value for it, so they are not going to -- because they can buy a face value bond at a higher interest rate. So what they will do is, if you have a $10,000 bond, they will lower the price of the bond until your bond is effectively paying 9% interest over the entire duration and then they will buy the bond at that price because that's is the going rates for bonds. Similarly, if you have an 8% bond and you held it for 10 years but now interest rates have dropped and you can only get a 10-year bond at only 7% interest, your 8% interest bond looks very attractive and people will pay you more for it to make the effective duration or yield on your bond 7% interest. So, bond prices will always fluctuate with whatever the current rate is and existing bonds, they will either pay less for them or more for them depending upon where they are in relation to other interest rates.