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## Macroeconomics

### Course: Macroeconomics>Unit 4

Lesson 1: Financial assets

# Relationship between bond prices and interest rates

AP.MACRO:
MEA‑3 (EU)
,
MEA‑3.A (LO)
,
MEA‑3.A.3 (EK)
Learn about the relationship between bond prices and interest rates. Through examples, you'll see how interest rates can impact what someone is willing to pay for the bond, and explore the math that explains the inverse relationship between interest rates and bond prices. Created by Sal Khan.

## Want to join the conversation?

• Sal, how do interest rates change in the first place? What does central bank do to influence interest rates? I am confused because I can't find the link between interest rates and the yield on bonds. Yields pertain to bonds and interest rate is just a general term. Please assist..
• Interest Rate (the one which Sal mentions as going up or down) is the benchmark rate (In US, it is the Fed rate). This is the rate at which Federal reserve is willing to lend money to the banks. Depending on a complex set of factors, the Fed changes these rates.

Yield on bonds is basically the annual rate of return the bond holder gets. By definition, the rate of return would depend on how much you pay for it. For the first purchaser of a bond (who directly buys it from the issuing entity), yield is same as coupon rate. However, for secondary purchasers, yield depends on the price at which the bond was purchased. If it was purchased at a discount, then Yield > Coupon Rate. If the bond was purchased at a premium, Yield < Coupon Rate
• I've read through the comments and i'm not alone. Despite that i've read more than 10 articles and 5 half hour videos on bonds. Nobody has explained what is meant by "interest rate" and reasoning of going up/down. Which interest rate? The Fed? Or the Coupon? Or The newly issued bonds vs old? If its the Fed what is the connection between. Pretty please explain the connection and the terms its too much ambiguity behind the term "interest rate". Thank you!
• The interest rate on debt with similar maturity to the bond in question.
• Im still confused, if the interest rate is higher, wouldn't someone invest more to get more raw amount of money as interest? Why would the investment be lower? Wither higher interest, the more you invest, the greater your benefit?
• If you bought a \$1000 bond that pays 5%, and the prevailing interest rate goes up to 10%, your 5% bond is worth less, not more. Why would someone give you \$1000 to earn \$50 each year when they could instead buy a "new" bond for \$1000 and earn \$100 each year? In order to make your bond attractive to them, you will have to sell it for less than \$1000.
• why would a company go for stocks if you can make bonds?
• First and foremost there is the issue of repayment with a bond that doesn't exist with a stock. Issuing bonds is creating debt, and at some point debts must be repaid. So, if you issue bonds and your company never turns a profit, you still have to pay back those bonds. Stocks, on the other hand, guarantee nothing. So if you never make a profit, you never pay dividends to stockholders.

Another reason that a company might choose stocks (or, equity) instead of bonds (or, debt) is that the interest payment on debts is an operating cost. That means your breakeven point as a company is higher with debt than it is with equity.

These are not the only reasons, just a couple of reasons why a company might prefer equity to debt.
• If the interest rate is high, doesn't it affect all the other securities and not just bonds?
• () Could zero coupon bonds with a \$1,000 face value be issued below par value? Does that happen often?
• They have to be issued below face value if they are zero coupon. The return to the investor comes from paying less than face and receiving face value at the end.
(1 vote)
• Let's say you buy a 2010 bond for \$200. If this 2-year bond was a zero-coupon bond, would the \$200 you get back in 2 years be in 2010 dollars or 2012 dollars?
(1 vote)
• dollars that you get in 2012 are 2012 dollars
If it's a zero coupon bond with face value of \$200, you wouldn't pay \$200 for it, you'd pay less than that. That's how zero coupon bonds give you your interest.
• If I buy a bond, and then the market interest rate goes up, why doesn't the interest rate on my bond increase as well?
Why am I stuck with the same interest rates?
(1 vote)
• Because that's what a bond is - a promise to pay a particular rate of interest and to repay the principal.
You lend me \$1000 and I agree to pay you \$50 per year in interest each year for the next 10 years, and then repay the \$1000. Next week interest rates rise. You can't come to me and say "I changed my mind, now you have to pay me \$100 each year". We had a deal. That's what a bond is. Likewise, if interest rates go down, I don't get to go to you and say "now I will only pay you \$25 each year". A deal is a deal.
• Is there any relation between the interest rate on bonds and the interest rate on loans or deposits in commercial banks ?
(1 vote)
• Yes, generally interest rates at banks move up and down together with interest rates on government bonds, although the "spread" also changes over time.