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Types of Bonds

Understanding Market Risk

Whether a bond pays the investor a fixed interest rate (also known as the coupon rate), which cannot be changed during the life of a bond, or a variable interest rate, the market price of a municipal bond will vary as market conditions change. If you sell your municipal bonds prior to maturity, you will receive the current market price, which may be more or less than the original price depending on prevailing interest rates at the time of the sale. So, for example, a municipal bond issued with a 5.0% coupon will sell at a premium if interest rates at the time of sale are below 5.0%. Consequently, it is important to understand that municipal bond prices fluctuate in response to the changing interest rates: prices increase when interest rates decline, and prices decline when interest rates rise.

It’s easy to understand the reasons:

  • when interest rates fall, new issues come to market with lower yields than older securities, making the older securities worth more, hence the increase in price; and
  • when interest rates rise, new issues come to market with higher yields than older securities, making the older ones worth less; hence the decline in price.
 

All information and opinions contained in this publication were produced by the Securities Industry and Financial Markets Association from our membership and other sources believed by the Association to be accurate and reliable. By providing this general information, the Securities Industry and Financial Markets Association makes neither a recommendation as to the appropriateness of investing in fixed-income securities nor is it providing any specific investment advice for any particular investor. Due to rapidly changing market conditions and the complexity of investment decisions, supplemental information and sources may be required to make informed investment decisions.