Which of the following statements is correct?
A) Interest rates and bond prices vary directly.
B) Interest rates and bond prices vary inversely.
C) Interest rates and bond prices are unrelated.
D) Interest rates and bond prices vary directly during inflations and inversely during recessions.

Question

Quizplus · Accepted Answer

Interest rates and bond prices vary inversely. This means that when interest rates rise, bond prices will fall, and when interest rates fall, bond prices will rise. This is because when interest rates increase, newer bonds will be issued with higher yields, making older bonds with lower yields less attractive to investors who are seeking the highest return. As a result, the price of older bonds must fall to maintain an equivalent yield to the newer, higher yielding bonds. Conversely, when interest rates decrease, older bonds with higher yields become more attractive, causing their prices to rise.

Which of the Following Statements Is Correct