Why do bond prices rise and fall?
A – Bonds, unlike stocks, pay a fixed rate of interest. Bond prices rise and fall inversely to interest rates. Suppose you pay $100 for a bond with a face value of $100, paying 5 percent per year and maturing in 10 years. At the end of 10 years, you are entitled to get back your $100, which is called your “principal.” Five years later, interest rates in the market for 5-year bonds rise to 6 percent. The price of your bond, which has five years left to maturity, will drop below $100 to the point that the buyer of your bond can earn 6 percent through the combination of the 5 percent interest payments and the gain from the price he or she price paid and the $100 face value due at maturity. This combination of fixed interest payment and variable principal value is called the “yield” on the bond.
