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Bond price and market yield

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A fixed-rate bond promises fixed payments. Its market price can change. Keep the payment promise separate from the resale price.

What a bond actually is

A bond is a loan to its issuer. Here we use a plain fixed-rate bond with $1,000 face value and a 4% coupon: $40 of promised interest each year. It cannot be called early. The issuer promises to repay $1,000 at maturity. Receiving those payments depends on the issuer paying as promised.

Now hold the payment schedule and credit quality constant. If the yield buyers demand rises from 4% to 6%, the price of this bond falls below $1,000. Buyers pay less for the same promised coupons and maturity payment.

If the required yield falls to 2%, the same bond trades above $1,000. The comparison includes both coupons and repayment of principal. Annual coupon dollars divided by price is current yield; it does not include the gain or loss between the purchase price and par.

The coupon matters as well as the maturity. Take two bonds alike in maturity and credit quality. When rates rise, the one with the lower coupon generally loses more value. So the bond whose price swings most is long and low: a long maturity and a low coupon, with a zero-coupon bond as the extreme case. Investors call this sensitivity duration. Duration is not the maturity date. A higher duration means a bigger price move for a given rate change, and a low duration does not mean low risk.

Exam terms

Bond
A loan to the issuer. The issuer promises to repay par at maturity and usually pays interest until then; a zero-coupon bond pays no interest along the way.
Coupon rate
Annual promised interest as a percent of par. Fixed for a fixed-rate bond.
Par (face) value
The principal promised at maturity; $1,000 in this example.
Market yield
The return investors currently demand for bonds of that quality and maturity.
Premium / discount
Trading above par / below par.
Interest-rate risk
The risk that rising yields push an existing bond’s price down.
Duration
How sensitive a bond’s price is to interest rate changes. Not the maturity date.
Price of a 10-year 4 percent bond against market yieldA downward-sloping curve. At a 2 percent market yield the bond is worth about 1180 dollars, at 4 percent about 1000 dollars, and at 8 percent about 732 dollars.PriceMarket yield$1,300$700

Up: price, $700 to $1,300. Across: market yield, 2% to 8%.

Market yield4.00%equal to the coupon
Illustrative price$1,000trading at par
A 10-year bond with a $1,000 face value and a fixed 4% annual coupon, priced by discounting its cash flows at the market yield. Accrued interest is excluded.

Price of an existing fixed-rate bond against market yield.

Which bond swings most

Less price sensitivityMore price sensitivity
  1. Short, high coupon
  2. Long, high coupon
  3. Long, low coupon
  4. Long, zero coupon
Other features alike: longer and lower-coupon bonds move more when rates change.

Try it: Move the market yield. Watch the illustrative price of a 10-year, 4% annual-coupon, $1,000 bond. Find the yield where the price is exactly par.

The ruleFor the same fixed payments, a higher required yield means a lower price, and a lower yield means a higher price. The fixed coupon rate stays the same. With other features alike, longer maturities and lower coupons generally have greater price sensitivity.

The closest contrast

Coupon rate: set in the contract, never moves.

Current yield and YTM: recomputed every time the price moves.

When a question says “yields rose”, it is telling you what the market demands now — not that the coupon changed.

Worked example

Priya bought a 10-year, $1,000 corporate bond at par with a fixed 4% coupon and no early-call feature. A year later, the required yield on bonds of the same credit quality and remaining maturity is 6%.

  1. Her promised annual interest is still $40. A rate change does not change the fixed coupon.
  2. A buyer values all remaining $40 coupons and the $1,000 maturity payment using the higher required yield. Their present value is lower.
  3. Her bond’s price falls below $1,000; it now trades at a discount.
  4. If she holds to maturity and the issuer pays as promised, she receives the scheduled interest and $1,000 principal. Selling at the lower price would realize a price loss. Holding does not remove credit risk or the loss of buying power from inflation.

Check yourself

Try a question, then read the explanation to review the rule.

Opening your study record…

Same rule, new context

Opening your study record…

Summary

  • Yields up, existing bond prices down. Yields down, prices up.
  • A fixed coupon rate does not reset when market rates change.
  • Other features alike, a longer maturity or a lower coupon generally means more sensitivity to a rate move. That sensitivity is called duration; it is not the maturity date.
  • Holding this bond to maturity returns par only if the issuer pays as promised. Rate changes affect its resale price; credit and inflation risks still matter.

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