What is the effect of rising interest rates on bond prices according to financial principles?

The effect of rising interest rates on bond prices is a fundamental concept in finance. When interest rates rise, new bonds are issued with higher yields as they need to compete with current market rates. Existing bonds, which were issued at lower interest rates, become less attractive under these circumstances. Investors demand a discount on these existing bonds in order to achieve a yield equivalent to the new higher rates available in the market.

As a direct result, the market prices of those existing bonds decline to adjust for the difference in yield, leading to a decrease in bond prices overall. This inverse relationship between bond prices and interest rates is a key principle that reflects how fixed-income investments react to changes in economic conditions. Understanding this principle is essential, especially for investors and financial professionals dealing in fixed-income markets.