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Scan for outdated or missing drivers - takes under a minuteDriver Scan →Clear out junk files and repair common Windows errorsFree Scan →When market yields on comparable bonds rise, the prices of existing fixed-rate bonds generally fall; when market yields fall, those prices generally rise. The bond’s coupon payment does not change. Its market price adjusts so its fixed cash flows remain competitive with what buyers can earn elsewhere.
Why bond prices and yields move in opposite directions
A bond is a loan to an issuer, such as a government, municipality or company. In return, the issuer promises interest payments and repayment of principal at maturity, subject to the bond’s terms and the issuer’s ability to pay.
For a fixed-rate bond, the coupon is set in the bond’s terms. If newly issued comparable bonds begin offering higher yields, an older bond with a lower coupon is less attractive at its old price. Its price generally has to fall for a buyer to receive a competitive yield. If comparable yields fall, the older bond’s fixed coupon may look more attractive, so buyers may pay more for it. Because that buyer pays more for the same promised payments, the yield on the purchase is lower.
The coupon itself has not changed: it is the bond’s market price, and therefore the return available to a new buyer, that adjusts. This inverse relationship is a general rule for fixed-rate bonds, not a guarantee that every bond’s price will move by the same amount.
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How a price change affects a bond’s yield
Bond prices are often quoted as a percentage of face value, also called par. FINRA’s example: a bond with a $1,000 face value quoted at 105 costs $1,050; quoted at 95, it costs $950. A price above par is a premium, while a price below par is a discount. A bond whose coupon is higher than yields on comparable new bonds will generally trade at a premium; one whose coupon is lower will generally trade at a discount. FINRA explains bond yield and return.
Consider a bond with a $1,000 face value and a fixed 3% coupon. If comparable market rates rise to 4%, buyers can seek higher yields from other bonds, so the 3% bond’s price generally falls. If comparable rates fall to 2%, its coupon looks more attractive and its price generally rises. The actual price depends on the bond’s remaining cash flows and other features, not just the coupon.
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SEC example: a Treasury bond with nine years remaining
The SEC’s 2013 illustration uses a $1,000 face-value Treasury bond with a 3% coupon. These are worked examples, not current market quotes:
| Example market-rate change | Illustrated bond price | Illustrated yield to maturity |
|---|---|---|
| Rate falls from 3% to 2%, with nine years remaining | $1,082 | 2% |
| Rate rises from 3% to 4%, with nine years remaining | $925 | 4% |
In both cases, the coupon remains 3%; the price changes to bring the bond’s return into line with the example market rate. The SEC’s Investor Bulletin on interest-rate risk dates to June 26, 2013.
Coupon rate, current yield and yield to maturity are different
- Coupon rate: The stated annual interest rate in the bond’s terms. For a fixed-coupon bond, it generally stays the same through the bond’s life.
- Current yield: Annual coupon income divided by the bond’s current market price. It changes when the price changes, even if coupon payments do not.
- Yield to maturity (YTM): A measure that equates the bond’s market price with the present value of its expected coupon and principal payments, assuming it is held to maturity. YTM is a comparison measure, not a guaranteed realized return: reinvestment, default or selling before maturity can change the investor’s outcome.
- Yield to call (YTC): A return measure based on holding a callable bond until its call date and receiving its call price. Yield to worst is also used when assessing callable bonds.
- Total return: Interest income plus market gains or losses, with applicable charges or commissions. It is not interchangeable with a quoted yield.
FINRA discusses these yield and return measures in its bond yield and return guide. When comparing bonds, make sure the yield figures use the same measure.
What makes a bond more sensitive to rate changes?
Duration, stated in years, is a measure of how much a bond’s price may fluctuate when interest rates change. Higher duration generally indicates greater price sensitivity, but it is a comparison tool rather than an exact forecast for every rate move. For otherwise similar bonds, longer maturities generally mean more sensitivity because cash flows farther in the future are more affected by discounting. Lower-coupon bonds are generally more sensitive than similar higher-coupon bonds.
When comparing bonds, consider these factors together:
- Yield measure and price versus par: Confirm whether the quoted figure is current yield, YTM, YTC or another measure, and whether the bond trades at a premium or discount.
- Duration and maturity: These help indicate exposure to changing market rates.
- Coupon: A lower coupon generally means more sensitivity than a higher coupon for otherwise similar bonds.
- Credit quality: Consider the issuer’s ability to make timely payments, not just the yield offered.
- Other terms and circumstances: Callability, liquidity, inflation exposure and the possibility that you may need to sell before maturity can all matter.
Why the inverse relationship does not tell the whole risk story
A bond can lose market value when rates rise, including a U.S. Treasury or a bond with an insurance or payment guarantee. A guarantee of promised payments does not protect the bond’s market price from changing. If an investor holds a bond to maturity and the issuer makes the promised payments, interim price movements may matter less—but holding to maturity does not remove every risk.
- Credit risk: The issuer may be unable to pay interest or principal.
- Inflation risk: Inflation can reduce the purchasing power of fixed payments.
- Liquidity risk: A seller may not find a buyer at a price reflecting the bond’s value.
- Call and reinvestment risk: An issuer may redeem a callable bond, often when rates have fallen, leaving the investor to reinvest at less attractive rates.
- Sale-before-maturity risk: If you need to sell when the market price is down, you may realize a loss; if it is up, you may realize a gain.
- Opportunity cost: Holding a bond can leave an investor earning less than newly available alternatives after market rates rise.
The SEC’s interest-rate-risk bulletin and its corporate bond bulletin explain these risks and the general price-rate relationship.
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