Rating Bond Prices

The key to bringing home the bacon in bonds is interest rates.

When you buy a bond, or a bond mutual fund, you can track its gains by watching rates. If they fall, bond prices rise. It's an inverse relationship.

Let's say the US Treasury issues a new batch of 30 year bonds today with an interest rate yield of 5.8 percent.

You buy one for $10,000. Soon, your next door neighbor begins to share your enthusiasm for bonds and decides to buy one at the next Treasury issue.

But by then, rates have fallen to 5.5 percent.

Your neighbor has a choice: Buy from the Treasury and get 5.5 percent, or buy your bond with its higher 5.8 percent. Yours pays more, so it's worth more. If he wants you to sell it, he needs to pay a premium above the $10,000 value of the bond.

That process occurs every minute of the trading day in bonds, whether or not new bonds are issued. Bonds trade like stocks, and their price depends on rates.

So beware. When rates rise, bond prices fall. Unless you hold them to maturity, bonds are as risky as stocks.