What is the typical relationship between rising interest rates and bond prices?

• A. Bond prices fall
• B. Bond prices rise
• C. Bond prices stay the same
• D. Bond prices become unpredictable

Answer: (A)

Rising interest rates push bond prices down because the payments a bond promises are fixed, while the value today depends on discounting those future cash flows at the going market rate. When rates go up, the new, higher discount rate makes each future coupon and the redemption worth less in present value, so the bond’s price falls to align its yield with current rates. New bonds issued at the higher rates become more attractive, which also drags down the price of existing bonds to make their yields competitive. The size of the price move depends on how long the bond lasts and its coupon: longer-duration bonds are more sensitive to rate changes, so they experience bigger price swings. If you hold the bond to maturity, you still receive the promised payments, but in the market the price shifts to reflect higher rates.