How do bond prices and yields relate when interest rates rise?

• A. As interest rates rise, existing bond prices typically fall to align yields with prevailing rates.
• B. Bond prices rise when interest rates rise.
• C. Bond yields are unaffected by changes in interest rates.
• D. Only new issues are affected; existing bonds remain the same.

Answer: (A)

Bond prices and prevailing interest rates move in opposite directions. When interest rates rise, existing bonds with fixed coupons become less attractive compared to new issues, so their market price falls. As the price drops, the fixed coupon represents a larger percentage of the price, pushing the yield higher to match the new, higher rates. For example, a bond with a $50 annual coupon on a $1,000 face value would yield about 5% at $1,000, but if rates rise to 6%, the price would fall until the $50 coupon yields roughly 6%. The main takeaway is that rising rates cause existing bond prices to fall and yields to rise, aligning with market rates.