What is the relationship between the interest rate and the price of the bond?
Question
What is the relationship between the interest rate and the price of the bond?
Solution
The relationship between the interest rate and the price of a bond is inversely proportional. This means that when interest rates rise, the price of a bond falls; and when interest rates fall, the price of a bond rises.
Here's why:
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When interest rates rise, new bonds come to market with these higher interest rates attached to them. As a result, existing bonds with lower interest rates become less attractive to investors, causing the price of these existing bonds to fall.
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Conversely, when interest rates fall, new bonds come to market with these lower interest rates. This makes existing bonds with higher interest rates more attractive to investors, causing the price of these existing bonds to rise.
This relationship is a fundamental concept in bond investing and is known as interest rate risk.
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