• Bond rates are based on several factors.silver bevel symbol percentage image by PaulPaladin from Fotolia.com
  
  Bonds are debt securities issued by government entities and corporations. Investors buy bonds to receive regular interest payments and their principal back when the bonds mature. Bonds are marketable securities which trade on the secondary bond market. In the market, bond prices will move up and down based on changing interest rates. An investor needs to balance several factors to pick the bonds that fit his investment goals.
  
  

Understand the Yield Curve

• The yield curve is a way to describe how interest rates change as bond maturities get longer. In a normal yield curve short term bonds have lower rates and rates increase as bonds lengthen in maturity. If the yield curve goes inverted, short rates will be higher than long term rates. To earn a higher bond, rate investors can go further out on the yield curve. For example, in May 2010 the U.S. Treasury yield curve had the one month rate at 0.14 percent, the one year rate was 0.43 percent, the 5 year bond paid 2.47 percent, 10 year Treasury bonds yielded 3.72 percent and the 30 year Treasury bond was at 4.53 percent.
  
  

Bond Rates Revolve Around the Treasuries

• Bills, notes and bonds sold by the U.S. Treasury set the baseline for all other bond rates. Bonds issued by the U.S. Treasury are considered to be the safest investment and they are widely traded, providing up to date interest rates. Other bonds are compared to Treasuries by looking at the rate premium the issue pays compared to the credit risk. How far a bond yield is above the comparable maturity Treasury bond gives investors a good idea how much risk is involved in the bond.
  
  

Credit Ratings Determine Rates

• Bond issuers are given credit ratings by the rating agencies like Standard & Poors, Moody's and Fitch Ratings. The lower a bond issuers rating, the higher the interest they must pay to sell bonds. Bond are dividend into investment grade with a credit rating of BBB or higher and non-investment grade bonds also known as junk or high yield bonds. Investment grade credit rating examples are McDonald's, rated A; Pfizer, rated AA and AIG with a BBB credit rating. Non-investment grade examples are Ford Motor Credit a BB- and First Data Corp at B-/CCC. Junk bond issuer Harrah's has a yield of 14 percent on 8 year bonds and McDonald's bonds pay 3.6 percent for the same maturity.
  
  

How Yields are Determined

• The U.S. Government and Treasury control the rates for short term dollar denominated debt. The Treasury sets a target for the Fed funds rate that banks use to lend each other short term money. Short term bond rates are then based on these rates. Long term bond rates are driven by market supply and demand. The main determinant of long term interest rates is the markets expectation for future inflation rates. If the market expects more inflation, bond interest rates will start to increase.
  
  

Rates and Prices

• Bond prices fall as interest rates rise and bond values increase when rates are falling. Bond investors who think rates will fall should buy longer term bonds. If interest rates are expected to increase, investors should buy short term bonds. A bond ladder of staggered maturities will allow the bond investor to maintain principal values and maximize the rate earned in any interest rate environment.