Question

What's the relationship between bond prices & the market interest rate? What's the logic behind this relationship?

Answer 1

The markety Interest rate and Bond price are inversely proportional. That is if the market Interest rate Increases, bond prices decreases and vice versa.

For example,

Consider a Bond with coupon rate 5%.

Scenario 1: When the Market interest rate is 4%.

When the Market Interest rate is 4% which is less than the Coupon rate, the bond gives higher return compared to market thus higher the Bond price will be.

Scenario 2: When the Market interest rate is 5%.

As the Coupon rate and the market interest rate remains same, bond will be selling at its par value.

Scenario 3: When the Market Interest rate is 6%.

In the above case, Coupon rate of bond is less than the market interest rate. The bond is giving less return compared to the market return thus reducing the price of the bond.