What happens to bond prices when interest rates increase?

• A. Bond prices fall because there is an inverse relationship between yields and prices.
• B. Bond prices rise as yields rise.
• C. Bond prices stay the same.
• D. Bond prices become more volatile with no directional trend.

Answer: (A)

When interest rates rise, bond prices fall. This happens because a bond’s payments are fixed. If new bonds are paying higher yields, the existing bond must become less expensive to offer a comparable overall return. The lower price increases the bond’s yield toward the new prevailing rate, keeping its attractiveness in line with new issues. This inverse relationship between price and yield is why a rise in rates leads to a drop in bond prices, and the effect is larger for bonds with longer duration. The other statements don’t fit because prices don’t rise when yields rise, they don’t stay the same, and there is a directional move rather than no trend.