What is the impact of market interest rates on bond pricing?

The relationship between market interest rates and bond pricing operates on a fundamental principle. When market interest rates rise, the existing bonds in the market, which pay fixed interest rates, become less attractive to investors. This is because new bonds are being issued at the higher current rates, offering better returns. Consequently, to make the older bonds competitive in the marketplace, the prices of these older bonds must decrease. Thus, higher market interest rates lead to a decrease in the value of existing bonds.

This dynamic is particularly important for fixed-income investors, as it highlights the inverse relationship between bond prices and market interest rates. If rates go up, the face value and the fixed coupon payments of existing bonds do not change, leading to a decline in their market prices to align with the new market conditions. Understanding this relationship is crucial for municipal finance officers and investment professionals when making investment decisions or analyzing the impact of interest rate changes on portfolios.