markets · Curated Lever · 4-7 min
Why does a bond's price fall when interest rates rise?
An old fixed payment must become cheaper to compete with a new higher yield.
The intuitive answer
The issuer automatically cuts the bond's promised payment.
The short answer
A fixed-rate bond keeps promising the same cash flows. When new bonds offer higher yields, investors will buy the old bond only at a lower price that makes its unchanged payments competitive.
The unseen lever
Market price adjusts so the present value and yield of fixed future cash flows reflect current required returns.
- 01Market interest rates rise
- 02New bonds offer higher returns
- 03The old bond's fixed payments look less attractive
- 04Its price falls until its yield is competitive
Concepts that unlock it
Coupon
A bond's scheduled interest payment.
Yield
Return implied by a bond's price and promised cash flows.
Present value
Today's value of future payments discounted at a required return.
Duration
A measure of how sensitive a bond's price is to interest-rate changes.
What if?
What if the bond matured tomorrow instead of in twenty years?
Check your understanding
Can you move the mechanism?
Question 1 of 2
Why must an old 2% bond fall when comparable new bonds yield 4%?
Choose the best explanation.
Question 2 of 2
Which is normally more rate-sensitive?
Choose the best explanation.
Evidence and limits
What supports this answer?
Market interest rates and prices of fixed-rate bonds generally move in opposite directions.
Limit: Credit risk, optionality and liquidity can also move a bond's price.U.S. Securities and Exchange Commission - Interest Rate Risk - When Interest Rates Go Up, Prices of Fixed-Rate Bonds Fall ↗Longer-maturity fixed-rate bonds are generally more sensitive to rate changes because more of their value arrives farther in the future.
Limit: Duration, not maturity alone, is the better sensitivity measure.U.S. Securities and Exchange Commission - Interest Rate Risk - When Interest Rates Go Up, Prices of Fixed-Rate Bonds Fall ↗