Interest Rate Scenarios
What a bond or a bond fund earns over one year and over many if rates rise, fall, or stay put, why the answer depends on how long you hold, and how closely the starting yield has matched what bond investors went on to earn.
The short version
Over one year, a bond fund earns roughly its yield minus its duration times the change in rates, so a rise can wipe out the income and a fall can multiply it. Over several years the picture reverses. After a rise, the fund earns the higher rate and overtakes where it would have been, at about the time its duration has passed. After a fall, the early gain is slowly given back. A single bond held to maturity pays what it promised either way. Across six decades of US data, the yield on a 10-year Treasury at the start of a decade has been a close guide to the return over that decade.
By the end of this lesson, you'll be able to
- Estimate a bond fund's one-year return for a given change in rates, and its break-even rate rise
- Explain why the effect of a rate change on an investor depends on their holding period compared with duration
- Describe how a single bond held to maturity differs from a fund when rates change
Why this matters
The last three lessons each supplied a piece: yield is what a bond pays, duration is how far its price moves, and the curve is where rates stand at each maturity. An investor usually asks something broader: what happens to my money if rates go up? The honest answer is "over what period?", and this lesson works through why. It uses scenarios, which means choosing a few possible paths for rates and following each to its result. A scenario works out the consequences of a path. It makes no claim that the path will happen.
One year: income against price
A bond investment earns income, and its price changes. Over a single year, a first approximation puts the two side by side.
One-year return ≈ Yield − Duration × Change in yield
| Fund | Rates fall 2 | Fall 1 | No change | Rise 1 | Rise 2 | Break-even rise |
|---|---|---|---|---|---|---|
| Short-term: yield 4.8%, duration 2 | +8.8% | +6.8% | +4.8% | +2.8% | +0.8% | 2.40 points |
| Intermediate: yield 5.0%, duration 6 | +17.0% | +11.0% | +5.0% | −1.0% | −7.0% | 0.83 points |
| Long-term: yield 5.2%, duration 16 | +37.2% | +21.2% | +5.2% | −10.8% | −26.8% | 0.33 points |
The funds are fictional, and the figures ignore convexity and the small change in income during the year. The three funds yield almost the same. What separates them is how wide the range of outcomes is.
The last column is the most useful single number in the table.
Break-even rise = Yield ÷ Duration
It's the rise in yields, over a year, that would cancel the year's income. The short-term fund can absorb a rise of 2.4 points before it shows a loss. The long-term fund is underwater after a third of a point. The higher the yield and the shorter the duration, the thicker the cushion. That explains 2022 in one line: the 10-year Treasury began that year yielding 1.52%, with a duration above 9, a cushion of about a sixth of a point, and yields then rose 2.36 points.1
The rest of this lesson is for members
Still to come in this lesson: Several years: the fund that recovers, One bond, held to the end, What the record shows, Running your own scenarios, the key takeaways, and 2 quiz questions with explanations.
Membership opens every lesson in the curriculum, the capstone projects, the interactive tools, and the members-only channels in the Hyperion Entities Discord. The first lesson of every module stays free.
Go deeper
- Bond Funds vs. Individual BondsFixed Income in Depth (depth track)
- Bond LaddersFixed Income in Depth (depth track)
- Interest Rate, Inflation, and Currency RiskPart 5: Building a Portfolio
- Simulating a Portfolio's FuturePortfolio Theory and Risk (depth track)
Notes and sources
- Federal Reserve Bank of St. Louis (FRED), from the Board of Governors of the Federal Reserve System. Treasury Constant Maturity yields, daily (series DGS3MO, DGS1, DGS2, DGS5, DGS10, DGS30), through October 8, 2026. Checked 2026-10-12. Back to text
- FINRA. Brush Up on Bonds: Interest Rate Changes and Duration. Checked 2026-10-12.
- Aswath Damodaran, NYU Stern School of Business. Historical Returns on Stocks, Bonds and Bills, with annual data through 2025 (updated January 2026). Checked 2026-10-12.