Question

How are bond prices determined in the market? What is the relationship between interest rates and bond prices?

Answer #1

**Solution)** The price of any bond is equal to the
sum of the present values of the coupon payments and the par value
received at maturity. The equation for pricing a bond is shown
as:

Where Ci = Coupon payment for the period i

r = Interest rate

n = Number of years to maturity

From the above equation, we can conclude that the bond price is inversely proportional to the interest rates. Hence, if the interest rate increases, the bond price decreases. While the bond price increases, when the interest rate decreases. Thus, there is an inverse relationship between the bond price and interest rates.

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