How do interest rates generally affect bond prices?

Understanding the relationship between interest rates and bond prices is fundamental for anyone involved in financial management. When interest rates rise, existing bonds with lower rates become less attractive to investors because new bonds are issued at higher rates. This decrease in attractiveness leads to a drop in the prices of existing bonds as investors demand a higher yield, which translates to a lower price for those bonds.

The fundamental principle at play is one of opportunity cost; investors will prefer to invest in new bonds that offer better returns when market interest rates are higher. Therefore, to sell existing bonds at the same nominal rate, their prices have to be reduced to make them competitive with new offerings.

Additionally, bonds with longer maturities are often more sensitive to interest rate changes compared to those with shorter maturities, further emphasizing the negative correlation between interest rates and bond prices. Thus, when interest rates rise, it indeed causes bond prices to fall. This principle is essential for evaluating market conditions and making informed investment decisions in the bond market.