Question

How the bond market reacts when the Federal Reserve increases short-term interest rates? How do short-term versus long-term bond prices react? How do Treasury bonds versus corporate bonds behave? Describe the relationship between interest rate changes and bond prices.

Answer 1

Increase in short term interes rates leads to a drop in the bond prices. Due to higher interest rates, the present bonds become less attractive and hence their market price decreases. Long term bond prices react more strongly since they are subject to a higher interest rate risk due to longer tenure. The treasury bonds do not fluctuate with changes in interest rates since they are risk free securities issued by the Government. Corporate bonds fluctuate and their prices have an inverse relation to interest rates.