Question

In a rising interest rate environment, how would bond values change over time? As a bond investor, what measures would you take to manage rate risk?

Answer 1

In the environment as the interest rate rises prices of the bonds falls. There is an inverse relationship between interest rate and prices of bond. This is called interest rate risk.

There can be many measures which can b taken to manage interest rate risk such as:

Investor can add more investments to the portfolio i.e diversification. Adding more bonds to the portfilio will reduce risk in case of bonds short term bonds can be purchased since they are less effected by changes in interest rates.

Investor can sell long term bonds and purchase short term bonds for a temporary period of time. After selling once the interest rate starts to change again investor can move to long term bonds

Investors can buy futures for bonds which will help them in locking the current rates and save from any further losses.

Risk can also be managed through hedging such as purchasing swaps , options and forward rate aggrements.