Bond Prices and Interest Rates: Why They Move Opposite

The idea in plain terms

A bond promises fixed coupon payments and the return of par at maturity. If new bonds pay more than yours, nobody will pay full price for yours, so its market price drops until its yield matches what the market now offers. If new bonds pay less, your higher coupon is worth a premium.

FINRA uses this same logic: an 8 percent bond is worth more in the secondary market when new issues pay only 5 percent. FINRA also notes that bond quotes are stated as a percent of par: a bond quoted at 105 trades at a premium at $1,050, and one quoted at 95 trades at a discount at $950.

Premium, par and discount

When the market yield equals the coupon rate, the bond prices at par. When the market yield is above the coupon rate, the bond prices at a discount. When the market yield is below the coupon rate, it prices at a premium. The worked example below shows all three.

Worked example: one bond, three market yields

A 10-year bond with a 5% coupon and $1,000 par. Coupons are paid semiannually ($25 every six months), the bond is priced on a coupon date so there is no accrued interest, and yield is quoted as twice the semiannual rate.

Price = the present value of the 20 coupons plus the par repaid at maturity, discounted at half the annual yield per period.

• Yields rose one point to 6% and the price fell to $925.61, a discount. Yields fell one point to 4% and the price rose to $1,081.76, a premium. At 5%, equal to the coupon, the bond prices at par.
• The moves are not symmetric: the same one-point change cut the price by 7.44% but raised it by 8.18%.
• Maturity matters. Same 5% coupon, yield up to 6%: a 2-year bond falls to $981.41 (-1.86%) while a 20-year bond falls to $884.43 (-11.56%). Yield down to 4%: $1,019.04 (+1.90%) for the 2-year and $1,136.78 (+13.68%) for the 20-year.

Common exam traps

• Direction: rates up means prices down. Questions often hide this behind wording like "new issues now pay more".
• The coupon does not change. When a bond's price moves, it is the yield to a new buyer that changes, not the dollars of interest paid.
• Discount versus premium: a market yield above the coupon rate means a discount; below means a premium.
• Quotes are percent of par, so a quote of 92.56 means $925.60 per $1,000 bond, not $92.56.
• In the example above, the longer maturity had the bigger price move for the same change in yield.

Practice and related pages

• Series 7 practice: corporate debt securities
• SIE practice: products and their risks
• Series 65 practice: securities characteristics
• Current yield vs. yield to maturity
• SIE vs. Series 7
• SIE practice questions
• Series 7 practice questions