True or False: A bond's yield is inversely related to its price.

The correct answer is true because a bond's yield and its price have an inverse relationship. When the price of a bond increases, its yield decreases, and conversely, when the price decreases, the yield increases. This relationship arises because yield is typically defined as the return an investor can expect to earn from a bond based on its coupon payments and current market price.

For example, if a bond is issued with a fixed coupon rate of 5%, and market conditions cause the price of the bond to rise above its face value, the yield on that bond, calculated as the annual coupon payment divided by the current price, will be lower than 5%. Conversely, if the bond's price falls below its face value, the yield will rise above 5%. This dynamic is critical for investors to understand, especially when trading bonds in varying interest rate environments, as fluctuations in market interest rates directly influence bond prices and yields.

Understanding this fundamental relationship between price and yield helps investors make informed decisions about bond investments, particularly in evaluating the attractiveness of bonds relative to prevailing interest rates and the overall bond market.