How does an investor typically respond to rising interest rates if they hold a bond with a high coupon versus new issues with higher rates?

• A. Prices rise, making the yield higher than new issues.
• B. Prices fall, lowering the bond's yield to align with new higher rates.
• C. Prices stay the same and yields rise.
• D. Prices rise and yields fall.

Answer: (B)

When market rates rise, the prices of existing fixed-rate bonds fall. This happens because new bonds are now issued with higher coupons, so to compete, older bonds need to become cheaper. Since the coupon payments on the old bond are fixed, a lower price increases its yield—its actual return if held to maturity—bringing it in line with the higher prevailing rates. A high-coupon bond does experience price decline, though often less than a low-coupon bond, because the larger coupon cushion keeps cash flows relatively attractive. As yields on new issues move up, the old bond becomes less attractive unless its yield has risen to match the new level. So, the key idea is that rising rates push down price and push up yield, aligning the bond’s return with the higher market rates.