Question

Assume a corporate bond pays a 5 percent coupon and matures in ten years. What will be the change in the current price of this bond if market interest rates increase from 5 to 5.5 percent?

Answer 1

The change in the current price of the bond when the market interest rates increase from 5% to 5.5% is a fall in the price of the bond.

What happens to bond prices with increased market interest rates?

The attractiveness of bonds occurs when the interest rates fall.  This fall drives up demand for bonds with fixed interest rates and the increasing demand causes bond prices to rise.

This implies that when interest rates rise, investors do not prefer the lower fixed interest rate paid by a bond.  The reduced demand for bonds results in their declining prices.

Thus, when interest rates rise, bond prices fall and when interest rates fall, bond prices rise.

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