Why Do Bond Prices Fall When Interest Rates Rise?

Companies and governments sell bonds at the par value with a stated interest rate. However, since bonds can be traded like stocks, the resale price will vary with market prices.

Effects

When interest rates rise, the price of a bond would have to decrease in order to increase the rate of return an investor would earn on the bond.

Interest Rates

When the interest rates of deposit accounts such as savings accounts and money market deposit accounts rise, investors will only invest in bonds if the rate of return on the bond increases as well. For the rate of return to rise, the price must fall.

Interest Accrual

The interest that is paid on a bond is determined by multiplying the par value by the stated interest rate. For example, a bond with a par value of $400 and a stated interest rate of 8.5 percent would pay $34 per year.

Considerations

The rate of return you get on your bond may be different depending on how much you paid for it because the interest payment is based on the par value, no matter what price you paid for it. If you paid less than the par value of the bond, your rate of return would rise.

Calculating Rate of Return

To calculate your rate of return, divide the annual interest payment by the price you paid for the bond. For example, if the price of the bond fell to $380 instead of $400 with a stated interest rate of 8.5 percent, the rate of return would rise to about 8.95 percent.

References

• Investopedia: Advanced Bond Concepts--Yield and Bond Price
• ABCs of Investing: How Do Interest Rate Changes Affect Bond Prices?