Question

Which of the following will happen when the yield on a bond goes up, assuming nothing else changes?

1. The coupon payments will increase
2. The coupon payments will decrease
3. The face value of the bond will increase
4. The bond price will decrease

		IV only
		II only
		II and IV
		I and III
		I only

Answer 1

Answer to the above question is IV only, that is, the Bond Price will decrease.

Let us understand how the Bond Market works.

Bond prices and yields move in opposite directions: When bond yields go up, prices go down, and when bond yields go down, prices go up.This happens largely because the bond market is driven by the supply and demand for investment money.

If we think logically, then why would an investor purchase a Bond with lower yield, when he or she could buy a Bond with higher yield from the market. Nobody would do that, so the original price of Lower Yield Bond now needs to be adjusted downward to attract buyers. Because the coupon or interest rate always stays the same, the bond's price must fall to keep the return from lower yield bond, the same as higher yield bond.