markets · Curated Lever · 5 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.
In 30 seconds
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.
Read the full explanation ↓The unseen lever
Market price adjusts so the present value and yield of fixed future cash flows reflect current required returns.
triggerMarket interest rates rise ↓increasesmechanismNew bonds offer higher returns ↓decreasesmechanismThe old bond's fixed payments look less attractive ↓decreasesoutcomeIts price falls until its yield is competitive
The deeper explanation
The short answer is the start, not the whole story.
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.
Common overstatements
A holder who keeps a default-free bond to maturity may still receive promised cash flows, but the opportunity cost and market value have changed.
Where the answer stops
Floating-rate and inflation-linked bonds respond differently from plain fixed-rate bonds.
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 ↗