Question

Describe the relationship between existing bond prices and market interest rates, and given a rising interest rate environment, why would an investor want to invest in bonds?

paragraph answer please

Answer 1

Let me explain how there exists a relationship between interest rate and bond prices with a simple example.

Let there be a bond that is issued 3 years ago redeemable after 7 years.

Bond price is 100 and the coupon rate is 6% per annum.

Let the market interest rate has been increased to 8%

Now why will someone invest in our bond that is priced at 100 which pays a interest at a rate of 6% only.

Hence if someone want to sell the bond they will sell it at a discount so that the price of the bond is adjusted to the interest rate at 8%

Hence the discount will be 6/0.08 = 75

So this bond should sell at a discount of $25 hence the bond prices and interest rate are inversely related.

After this explanation as the interest rates are raising the bond prices fall hence the investors try to buy the bonds as they are lower priced anticipating that going forward the market stabilises .