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Why do bond prices fall when yields rise?
A fixed-rate bond promises specified coupon payments and repayment of its face value at maturity, provided the issuer pays as promised. If market yields rise, newly issued bonds may offer more attractive returns. Buyers will generally pay less for an older bond with lower fixed payments, so that its return at the lower purchase price is more competitive.
This is the arithmetic of valuing fixed future cash flows at a higher required return—not a change to the bond’s coupon. The SEC summarizes the relationship this way: “When market interest rates rise, prices of fixed-rate bonds fall.” SEC Investor Bulletin: Interest Rate Risk.
Coupon rate and yield to maturity are different
The coupon rate is the bond’s stated annual interest as a percentage of its face value. Yield to maturity (YTM) is a return measure that takes the purchase price and the bond’s promised cash flows through maturity into account, subject to its assumptions. It is useful for comparing bonds, but it is not the same thing as the coupon rate.
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- If an otherwise comparable bond is bought below face value, its YTM is higher than it would be at face value.
- If it is bought above face value, its YTM is lower than it would be at face value.
So a bond can continue paying the same coupon while its YTM changes when its resale price changes. The SEC discusses this distinction in its corporate-bond bulletin.
What happens in a worked example?
The SEC’s simplified illustration starts with a Treasury bond that has a 3% coupon and a $1,000 face value. After one year, with nine years remaining, market rates rise from 3% to 4%. In that example, the bond’s price falls from $1,000 to $925 and its YTM rises from 3% to 4%, while its coupon remains 3%.
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This is an illustration, not a rule that every bond loses 7.5% whenever rates rise by one percentage point. The size of a price change depends on the bond’s cash flows and other characteristics.
The direction reverses in the SEC’s companion illustration: with market rates falling from 3% to 2%, the example bond’s price rises from $1,000 to $1,082, and its YTM is 2%. Both examples show how price and yield move in opposite directions for fixed-rate bonds. SEC Investor Bulletin: Interest Rate Risk.
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Which bonds are more sensitive to rising yields?
When comparing bonds with similar credit quality and other terms, two features help indicate relative sensitivity. These are general relationships, not precise price forecasts.
Maturity
Longer-maturity bonds generally have greater interest-rate risk than shorter-maturity bonds. More of their cash flows arrive further in the future, leaving more time for changes in required returns to affect their value.
Coupon
All else equal, a lower-coupon bond generally has greater sensitivity to rate changes than a higher-coupon bond with a similar maturity and credit quality. The SEC’s investor bulletin and corporate-bond bulletin explain these interest-rate-risk factors.
Independent reader supportYour contribution helps us test, update, and keep practical guides available for everyone.Does holding a bond to maturity prevent a loss?
Holding a bond to maturity can avoid selling at an interim market price that is below what you paid. If the issuer makes the promised payments, the bond continues to pay its coupons and its face value is due at maturity; a change in market price alone does not change those contractual amounts.
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One free scan finds every outdated or missing driver and matches the right update for your exact hardware.Free scan · exact hardware matchThat is different from guaranteeing a return in every circumstance. Corporate bonds carry default risk, and selling before maturity can result in a gain or loss relative to the purchase price. U.S. government backing does not guarantee a stable market price if a Treasury or other government-backed bond is sold early. See the SEC’s bond investor bulletin and corporate-bond bulletin.
What should you check before selling early?
A quoted price is not necessarily the only cost of selling. A broker may charge a commission or apply a markdown to the bond’s price, and costs can vary by firm. Before deciding, compare the price offered with your purchase price and ask the broker what commission or markdown applies. The SEC’s bond-sale guidance explains these potential costs. Whether to sell depends on your circumstances; this overview is not individualized investment advice.
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