Why there is an inverse relationship between market interest rates and bond prices
When market interest rates rise, bond prices fall — and when rates fall, bond prices rise. This happens because a bond pays a fixed cash amount, so its value shifts to keep pace with changing rates elsewhere.
Formula
Bond yield = Coupon payment ÷ Market price of bond
Real World
When the Bank of England raised interest rates to 5.25% in 2023, UK gilt prices fell sharply because the fixed coupons on existing bonds looked less attractive compared to newly issued higher-rate bonds.
Exam Focus
Always demonstrate the inverse relationship with a numerical example — examiners award marks for showing yield rising as price falls.
Price Elasticity of Demand
PED = % change in quantity demanded ÷ % change in price
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