Bond prices move against interest rates, and the reason is arithmetic

What follows is an argument about how bonds work, and about where the received version of it stops being true.

The fixed payment is the whole explanation

A conventional bond promises fixed interest payments and the return of a fixed sum at a fixed date. If market interest rates rise, a newly issued bond pays more, so nobody will pay the old price for the old bond. The old bond's price falls until its remaining payments represent the same yield as the new one.

Nothing about the bond changed; the price adjusted because the payments could not.

Yield and price are two views of one number

The yield is the return implied by paying today's price for the remaining payments, so quoting one determines the other. This is why financial reporting sometimes says yields rose and sometimes says prices fell, and means the same event. A bond bought at a lower price has a higher yield to maturity, all else equal.

Confusing the coupon — the fixed rate printed on the bond — with the yield is a common and consequential error.

Time amplifies the effect

A bond maturing next year has one more payment and a near-term repayment, so its price barely moves when rates change. A bond maturing in thirty years has decades of fixed payments that are now mispriced relative to the market, so its price moves a great deal.

This sensitivity is measured as duration, and it is roughly how much the price moves for a one-point change in rates. It explains why long-dated government bonds, often described as safe, can fall substantially in a year when rates rise.

Two different risks with the same name

Credit risk is the chance the borrower does not pay, which is why corporate bonds yield more than government ones from the same currency area. Interest rate risk is the price movement described above, which affects even bonds certain to be repaid. A government bond can have almost no credit risk and a great deal of interest rate risk at the same time.

Products described simply as bonds can carry very different mixtures of the two.

Holding to maturity changes what you are exposed to

If you hold an individual bond to maturity and it is repaid, the interim price movements do not affect what you receive. Bond funds have no maturity date, so their price reflects the market continuously and there is no date at which you get a fixed sum back.

The arithmetic is straightforward: this is the practical difference between owning bonds and owning a bond fund, and it is frequently glossed over. Neither protects against inflation, which erodes the real value of fixed payments regardless of whether you hold to maturity.

Assume any product feature can be withdrawn at renewal.

Index-linked bonds address a different problem

Some governments issue bonds whose payments rise with a published inflation index, which removes much of the inflation risk. They still carry interest rate risk in real terms, and can fall in price substantially. They are priced accordingly, so the protection is not free and the starting real yield can be negative.

Whether any of these instruments suit an individual depends on their circumstances, and this is general information rather than a recommendation.

The takeaway

The payment is fixed, so the price has to move. How much it moves depends mostly on how far away maturity is.

The decision is rarely about picking the best option — it is about avoiding the expensive one.