How does the value of a bond relate to interest rates?

The value of a bond is inversely related to interest rates, meaning that when interest rates rise, the value of existing bonds typically falls, and vice versa. This relationship can be explained as follows:

When interest rates increase, newly issued bonds come to the market offering higher yields than existing bonds. As a result, the older bonds, which have lower rates, become less attractive to investors. To compete with new bonds, the price of existing bonds must decrease to offer a yield that is competitive with the new market rates. Conversely, when interest rates decline, existing bonds with higher fixed interest payments become more desirable. Consequently, their prices will increase because investors are willing to pay a premium for the higher returns they offer compared to new bonds issued at lower rates.

This fundamental concept illustrates how interest rate movements affect bond prices and is crucial for understanding bond market dynamics.