Why Does an Increase in Interest Rates Make Bond Prices Go Down?

May 5, 2009

Also what are the other factors that affect bond prices, and what effects do they have on the price?

{ 1 comment… read it below or add one }

Jack May 5, 2009 at 12:10 pm: Interest rates and bond prices have an inverse relationship. As illustrated below, when interest rates rise, bond prices generally fall. Conversely, when interest rates decline, bond prices tend to rise.

When rates go up, newly issued bonds come to the market with higher yields than existing bonds. The newly issued bonds are more attractive than comparable existing bonds with lower yields. In order to sell their existing bonds, investors have to reduce their prices to make them equally attractive.
Generally speaking, the prices of longer-term bonds are more sensitive than shorter-term bonds to changing interest rates. Similarly, fixed income funds with longer average maturities tend to be more sensitive to interest rate changes than funds with shorter average maturities.