Relationship between bond prices and interest rates | Finance & Capital Markets | Khan Academy

Khan Academy2 minutes read

Bond prices move inversely to interest rates, with examples showing how a $1,000 bond's price changes based on varying rates, explaining the price adjustments in detail. Additionally, the text highlights the relationship between interest rates and zero-coupon bond prices, demonstrating how these prices increase as interest rates decrease.

Insights

  • Bond prices change in opposition to interest rates; when rates rise, bond prices fall, and when rates drop, bond prices rise.
  • The price of a bond is intricately linked to prevailing interest rates, with fluctuations in rates directly impacting the value of the bond, especially evident in zero-coupon bonds that see a rise in price with lower interest rates.

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Recent questions

  • How do bond prices change with interest rates?

    Bond prices move inversely to interest rates. When interest rates rise, bond prices decrease, and when interest rates drop, bond prices increase.

  • What happens to bond price if interest rates rise to 15%?

    If interest rates rise to 15%, the bond price decreases due to the lower coupon rate compared to the market rate.

  • How does a $1,000 bond with a 10% coupon work?

    A $1,000 bond with a 10% coupon pays semi-annually, with the initial price set at $1,000 based on the 10% coupon rate.

  • Why does the price of a bond decrease with higher interest rates?

    The price of a bond decreases with higher interest rates because the coupon rate becomes lower compared to the market rate, leading to a decrease in bond price.

  • What happens to the price of a zero-coupon bond with lower interest rates?

    The price of a zero-coupon bond rises with lower interest rates, as the bond becomes more valuable in comparison to the market rate.

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Summary

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Bond prices and interest rates relationship explained

  • Bond prices move inversely to interest rates
  • Example of a $1,000 bond with a 10% coupon paid semi-annually
  • Diagram illustrating coupon payments over two years
  • Initial price of bond set at $1,000 based on 10% coupon rate
  • If interest rates rise to 15%, bond price decreases
  • Price reduction explained due to lower coupon rate compared to market
  • Conversely, if interest rates drop to 5%, bond price increases
  • Calculation for zero-coupon bond price at different interest rates
  • Price of zero-coupon bond rises with lower interest rates
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