Question

Are bond price and interest rates directly related (that is, they move in the same direction), or inversely related (that is, they move in opposite directions). Provide an explanation in support of your answer.

Answer 1

Bond price have inverse relation between interest rate. This is because of that the bond prices will fall down with increasing the cost of borrowing money. Bonds are like debt instruments, where the condition existed between the borrower and the lender that the borrower will pay the money back after the bond reaches its maturity period. The demand for the bonds and its prices will change according to the fluctuations in interest rate. If the bonds are in higher interest rate in the market, the rate of existing bonds will fall down with falling demand for bonds. On the other hand, the new bonds with lower interest rate will increase the demand for the bonds in the market.
The value of the bonds was determined with respect to the discounted cash flow in future by accessing the present value of the bonds in the market. For example, a trader hold a bond with 5 percent interest rate, but a new bond was issued in the market with 10 percent interest rate. This will lead to the selling of the 5 percent bond in the market at a discount on secondary market to dispose the investment. The changes in the interest rate expectations will affect the return over the bonds. Long maturity bonds have the ability to compensate risk of investors.