Question

In a letter to your 12 year old brother explain why the price of a bond and in the interest earned on the holding of a bond must move opposite direction. Please make in a letter.

Answer 1

Hi Tom,

I hope you are doing well. In the previous letter you wanted to know what is the relation between bond price and interest rate and why? Today, I am going to explain you this.

Suppose, you bought a bond for $100 and it has 6% coupon rate annually. Now, if interest rate goes up to 7% in the market. So, for buyers in the market are getting 7% coupon rate for the price of $100, and if you want to sell the bond the other buyer will be reluctant to pay $100, they will offer you less than $100 as they getting more attractive rate at $100. S, you bond price goes down. Similarly, if the interest rate goes down. Other buyers will be willing to pay higher price than $100 as they are getting more interest than $100. So, your bond price will go up.

I hope this explanation will clear your understanding and concept of bonds. If there still doubt in your mind,give a call to discuss this further.

Your Elder Brother,

Michael