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Understanding Market Risk

While the interest payment, also known as the coupon rate, cannot be changed during the life of a bond (unless, of course, it is a variable-rate security), the market price of a security changes 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 their original price. Consequently it is important to understand how the direction of interest rates might affect the value of your holdings. As with other fixed-income securities, municipal bond prices fluctuate in response to 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.
  • 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.

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