Bonds 101: Why Prices Fall When Yields Rise

A bond is, at its core, a loan: an investor lends money to a government or a company, which promises to pay back the principal at a fixed future date (maturity) and make periodic interest payments (the coupon) in the meantime. What confuses most new investors is that once a bond is issued, its price in the secondary market moves in the opposite direction to prevailing interest rates — and that relationship, once you see the intuition behind it, stops being confusing at all.

The intuition, with a simple example

Say a government issues a bond paying a 5% annual coupon on a face value of ₹1,000 — so it pays ₹50 a year. A year later, interest rates in the broader economy rise, and the same government now issues new bonds paying 7% to attract buyers. Nobody would pay full price for the old 5% bond when a brand-new bond offers 7% for the same risk — so the price of the old bond has to fall until its ₹50 annual coupon represents a 7%-equivalent yield to a new buyer. That price decline is exactly what "yields rise, prices fall" describes: the coupon is fixed, so the price is the only variable that can adjust to make the bond competitive with prevailing rates.

Duration: why some bonds move more than others

• Longer-maturity bonds are more sensitive to interest rate changes than shorter-maturity bonds, because a rate change affects a longer stream of future cash flows.
• This sensitivity is measured by a metric called duration — roughly, the weighted-average time until a bondholder receives their cash flows, adjusted for how much each payment matters to the bond's value.
• A bond with a duration of 7 years will move roughly 7% in price for a 1 percentage-point move in yields — which is why long-duration bonds are considered a higher-risk, higher-volatility way to express a view on interest rates than short-duration instruments.

This relationship is also why bond investors watch central bank policy so closely: a rate hike doesn't just make new borrowing more expensive, it directly repriced the entire existing stock of outstanding bonds downward, and a rate cut does the reverse. Understanding this one mechanism unlocks most of what makes fixed income investing distinct from equity investing.