What happens to current bond prices when interest rates rise?

What happens to current bond prices when interest rates rise?

• A. They rise because existing bonds become more attractive
• B. They fall because new bonds carry higher yields
• C. Rates do not affect bond prices
• D. Only long-term bonds are affected by rate changes

Answer: (C)

Interest rates and existing bond prices move in opposite directions. When market rates rise, the fixed coupons on current bonds look less attractive compared with new issues that pay higher yields. To compete, the price of the existing bond must drop so its yield rises to match prevailing rates. This happens because the bond’s future cash flows are discounted at the higher rate, reducing their present value. The result is a fall in price for all bonds, with longer-duration bonds typically more sensitive to rate changes, though the direction is the same for everyone. The idea that rates don’t affect prices, or that only long-term bonds are affected, or that prices rise when rates go up, doesn’t fit how bond prices and yields interact.

Interest rates and existing bond prices move in opposite directions. When market rates rise, the fixed coupons on current bonds look less attractive compared with new issues that pay higher yields. To compete, the price of the existing bond must drop so its yield rises to match prevailing rates. This happens because the bond’s future cash flows are discounted at the higher rate, reducing their present value. The result is a fall in price for all bonds, with longer-duration bonds typically more sensitive to rate changes, though the direction is the same for everyone. The idea that rates don’t affect prices, or that only long-term bonds are affected, or that prices rise when rates go up, doesn’t fit how bond prices and yields interact.