Relationship Between Price of A Bond And The Prevailing Interest Rate

The price of a bond is inversely proportional to the rate of interest in the economy.

Making an investment in bonds can be quite a daunting process that not many investors opt for. That is so because it requires some amount of knowledge on how the economy works, so that one can decipher the effect of various factors on bond prices.

For instance, the prevailing rate of interest has a deep impact on the price movements of bonds. Usually, an inverse relationship can be traced between the two. This means that the value of a bond goes up when the interest rate goes down and vice versa.

The rate of interest has an impact on the price movements of bonds. Usually, an inverse relationship can be traced between the two.

How does it work?

It is important to note that if you hold the bond until maturity, you are entitled to receive the face value of the bond, irrespective of the prevailing interest rate. The change in interest rate affects the price of your bond only if you decide to sell it in the secondary market before maturity.

Let us understand this with the help of an example. Say you buy a bond with face value of Rs 10,000 with a coupon rate of 10 percent and maturity of eight years. This means you should get Rs 1,000 as interest every year, and Rs 10,000 on maturity.

However, if the prevailing interest rate increases after four years of investment, then new bonds issued by same company would offer a higher rate of return, say for instance 12 percent. If you decide to sell your bond (that offers 10 percent interest) in the secondary market at this point of time, not many investors would be interested in buying it, since they would prefer newly-issued bonds at 12 percent.

If you still want to sell your holdings, you would have to sell them at a price below the face value in order to attract buyers, effectively reducing their price. The value of a bond hence decreases if the interest rate increases and vice versa.


This article (“Article”) is licensed to or is the property of Religare Corporate Services Limited (“RCSL”, which would mean to include its group companies, wherever applicable). This Article should not be reproduced or redistributed to any person or in any form in whole or in part without prior and explicit written consent of RCSL. This Article reflects the views of the author or content provider, and RCSL disclaims all liability, whatsoever, arising out of the substance or contents of this Article or in connection thereto, including any matter relating to infringement of intellectual property rights. This Article is purely for the purpose of public awareness and education and any reference to any financial product should not be construed as an offer or solicitation of an offer to buy or sell any securities, financial instruments or insurance. RCSL does not guarantee the accuracy or completeness of the information contained herein and there can be errors both typographical and in content. The Article may be referred only as a general guide and not as the ultimate source of the subject matter discussed. The Article must not be relied upon for taking personal, medical, legal or financial decisions and an appropriate professional must be consulted for specific advice tailored to specific situations. RCSL and any persons connected thereto do not accept any liability arising from the use of this Article. This disclaimer forms a part of, and should be read in consonance with, the Terms and Conditions of this site.

Copyright 2012 Religare. All rights reserved. Trademarks are the property of their respective owners.

This site is best viewed with Internet Explorer 7.0 or higher; Firefox 2.0 or higher.