How does market interest rate influence bond prices?

Market interest rates have a direct inverse relationship with bond prices, which is a fundamental concept in fixed-income investing. When market interest rates rise, existing bonds, which were issued at lower rates, become less attractive to investors. As a result, the prices of those existing bonds decline. This happens because newer bonds are likely to be issued at the higher prevailing rates, offering more compelling returns compared to the older bonds.

This dynamic is primarily driven by supply and demand: as new bonds are issued at higher rates, the demand for older bonds offering lower rates diminishes, leading to a decrease in their prices in the secondary market. Conversely, when market interest rates fall, existing bonds with higher rates become more appealing, resulting in an increase in their prices.

Understanding this relationship is crucial for investors and wealth management professionals, as it helps in making informed decisions regarding bond investments and managing interest rate risk within a portfolio.