Why do Bond costs and Interest Rates have this Strange Relationship

It's a question that happens to several World Health Organization invest in fetters – why do bond costs associate degreed interest rates continually move in opposite directions? they are doing have an inverse relationship, actually. once bond costs go up, their interest rates go down. And it works the opposite approach, too. Why is that this exactly?

It looks illogical to the novice initially that bond costs associate degreed interest rates would have an inverse relationship like this. you wish to seem to a small degree nearer to envision however it is smart. As the simplest way to grasp, attempt to take into account however zero coupon bonds work.

Zero coupon bonds square measure priced on the distinction in value that there's between the worth paid at maturity and also the terms. associate degree example may create this easier to grasp. for example that there's a zero bond that trades at $900 once its nominal value is $1000. Then, you calculate the bond's right of come as 1000-900/900, or 11%.

Anyone paying $900 for this bond would want to be pleased with a 11 November come. they don't seem to be presupposed to merely look into this figure, though. they have to seem at what else is on supply within the bond market very apprehend if this rate of come is satisfactory.

Bond investors can continually rummage around for the most effective doable come like alternative investors. As current interest rates amendment and new bonds begin to induce issued at 12-tone system yield, the 11 November from the bond of recent can begin to seem not that enticing any longer.

For the recent zero coupon bonds to still be ready to attract investors, they might got to be taken down and repriced to be ready to match the sort of yield offered by the freshly issued bonds. they could want during this case, to be repriced at maybe $875, to compete.

This is however bond costs and interest rates move in opposite directions. once the interest rates move up, they need to reprice the bonds to be cheaper. What happens once the rates go down rather than up? If the rates were to drop to 100 percent, then our 11 November bond would definitely look terribly enticing, indeed. Of course, the bond issuers wouldn't wish to lose out. in order that they would want to create their bonds dearer.

In general, investors find it irresistible once interest rates fall, and bond provision establishments find it irresistible once they rise. that is the approach these items work.