What happens to bond prices when interest rates rise?

When interest rates rise, bond prices fall due to the inverse relationship between interest rates and bond prices. When new bonds are issued with higher interest rates, existing bonds with lower interest rates become less attractive to investors. As a result, in order for these existing bonds to compete in the market for investor interest, their prices must decrease.

In more detail, every bond has a fixed coupon payment based on its initial interest rate. If prevailing interest rates increase, new bonds offer higher coupon payments, leading investors to prefer those new offerings. Consequently, the price of older bonds must drop so that their yield—that is, the return an investor would earn if they purchased the bond at its new lower price—aligns more closely with the new higher rates available. This concept hinges on the opportunity cost of holding existing bonds when better return opportunities arise in the market.

Therefore, option B correctly describes the relationship: as interest rates increase, bond prices decrease.