Bond Prices Essay

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Discuss the relationship between bond prices and interest rates. What impact do changing interest rates have on the price of long-term bonds versus short-term bonds? Answer Bond prices are inversely proportional to interest rates. For eg if interest rates rises bond prices fall and vice versa. This happens due to the fact that when the general interest rate rises, bond rate of interest remain constant, future cash flows from the bond are discounted at higher rate of interest leading to lower bond price. Similarly, when the general interest rate fall, bond rate of interest remain constant, future cash flows from the bond are discounted at lower rate of interest leading to higher bond price. Long term bonds are more susceptible to price fluctuations due to changes in interest rates as compared to short term bonds. For eg, when the general interest rate rises, bond rate of interest remain constant, future cash flows of higher number of years from the long term bond are discounted at higher rate of interest leading to lower bond price. Similarly, when the general interest rate fall, bond rate of interest remain constant, future cash flows from the lesser number of years of short term bonds are discounted at lower rate of interest leading to higher bond price than the longer term bonds. Same holds true in reverse situation. . . . . . . . When interest rates rise, long term bonds should be sold first then short term bonds. When interest rates fall, long term bonds should be purchased first then short term bonds. . . . . . REPLY 1: The reason that validates the claim that Bond Prices would certainly rise with falling interest rates would be, from the point of view of an investor, he/she always looks for opportunities to maximise his/her gains. With Bank providing lesser value for your Investment, People look at other opportunities to

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