Supply and demand
As with all marketable assets, corporate bond prices depend on supply and demand. Demand is subject to the attractiveness of a bond relative to other available investment opportunities.
Supply is subject to the financing needs of a company and the cost of borrowing given alternative credit channels. Interest rates play a key role in both sides of the market dynamic.
Interest rates
Interest rates are a central factor in both the supply and demand for bonds. If interest rates are lower than the coupon rate on a bond, the bond offers a better return and demand will likely rise. If interest rates rise above the coupon rate, demand for the bond is likely to drop. On the supply side, companies will be hesitant to issue bonds if interest rates are too high.
The general rule is that interest rates and bond prices are inversely correlated – as one rises, so the other falls.
How close the bond is to maturity
New bonds will always be priced taking current interest rates into account. This means that they’ll usually trade at or near their face value. During the bond’s lifespan, its price should fluctuate with movements in the interest rate. By the time a bond has reached maturity, however, it’s just a pay out of the original loan – meaning that a bond will move back towards its par value as it nears this point.
Credit ratings
Whereas bonds are often thought of as conservative investments, defaults can still happen – especially with corporate bonds. The main way of determining the risk of a corporate bond issuer defaulting is through its rating from agencies like Standard & Poor’s, Moody’s and Fitch Ratings. A riskier bond will usually trade at a lower price than a bond with lower risk profile and a similar coupon.
Inflation
High inflation can negatively affect the price of a bond. There are two reasons for this. Firstly, the bond’s fixed coupon payment amount becomes less attractive when money loses its purchasing power. Secondly, monetary authorities like the Bank of England (BoE) often raise interest rates when inflation is high. Because interest rates and bond prices are inversely related, higher interest rates result in a lower market price for the bond.