The Short Answer:
An existing fixed-rate bond promises a set of coupon payments. If comparable market yields rise, newly issued bonds can offer a higher return, making the old bond less attractive at its previous price. The old bond’s coupon does not change.
Instead, its market price falls, so a buyer paying the lower price can earn a higher yield from the remaining coupons and principal repayment. Bond coupons are fixed. Market-required returns are not. Price is the variable that reconciles the two. The reverse generally holds when comparable yields fall: an existing bond’s fixed payments become more attractive and its price rises. This is a relationship between the bond’s price and comparable market yields, not a rule that every Fed rate change moves every bond by the same amount.Why It Affects Investors
A bond can be relatively safe from default and still lose market value before maturity. U.S. Treasuries, for example, have interest-rate risk even though their credit risk differs from that of corporate bonds. If you need to sell an individual bond, or you own a bond fund or Treasury ETF whose holdings are marked to market, a rise in relevant yields can affect immediately.
The Simple Mechanism: Old Bonds Compete With New Bonds
Imagine an existing fixed-rate bond with a $1,000 face value and a 3% coupon.
It pays $30 a year in total. Now suppose a comparable newly issued bond offers 4%, or $40 a year on $1,000.
Why pay $1,000 for the old bond’s $30 annual coupon when a similar new bond offers $40? The old issuer has not changed its promise. The alternative return has improved. Bond prices fall when rates rise not because the old bond suddenly becomes worse, but because the alternatives become better.
Why Does the Price Have to Fall?
The old bond’s contractual payments are fixed. Its secondary-market price is the variable that can adjust. At a discount, a new buyer receives the same $30 annual coupon but pays less upfront and, assuming the issuer pays as promised, receives the $1,000 face value at maturity. Those payments and the eventual difference between purchase price and face value together raise the buyer’s yield to maturity toward the return available on comparable bonds.
That is why a 3% coupon does not turn into a 4% coupon. The coupon stays 3% of face value; the return available at the new market price changes.
Bond Price and Yield Move in Opposite Directions
For a fixed set of promised cash flows, a higher required yield means a lower price; a lower required yield means a higher price. This is the familiar inverse bond price–yield relationship. The size of the move depends on the bond’s remaining cash flows and on how much comparable yields change. It is not a fixed percentage response to a change in the Fed’s policy rate.
An SEC Illustration: $1,000 Becomes About $925
The SEC offers a more precise illustration. A Treasury security starts with $1,000 face value, a 3% coupon paid semiannually, and 10 years to maturity. One year later, nine years remain and the comparable market rate has risen from 3% to 4%. Its illustrative price falls to about $925, while the yield to maturity for a buyer at that price rises toward 4%.
The coupon did not change. The price did. The $925 figure depends on this example’s maturity and payment assumptions; it is not the price response of every 3% bond to a one-percentage-point rise in rates.
Why Do Longer-Term Bonds Usually Move More?
Other things equal, a bond with more distant payments is generally more sensitive to a change in required yield. Duration is a more precise measure of that price sensitivity than maturity alone. For this Guide, the practical point is simple: two bonds can face the same rise in market yields but experience different price changes.
What If You Hold the Bond Until Maturity?
If you hold an individual bond until maturity and the issuer makes all promised payments, interim changes in its market price do not change its contractual coupons or principal repayment. That does not eliminate opportunity cost: your 3% bond can keep paying 3% while comparable new bonds offer 4%. Nor does it remove issuer default risk, inflation risk, or the possibility that you must sell before maturity. A bond fund has a portfolio of holdings and does not give each fund investor the same individual-bond hold-to-maturity outcome.
Does This Apply to Every Bond in the Same Way?
No. The mechanism is clearest for a conventional fixed-rate bond when comparable required yields change and other factors are held constant. A floating-rate security can reset its coupon and may have less rate sensitivity than a comparable fixed-rate security. Corporate bonds also respond to changes in credit spreads, issuer prospects, liquidity, and sometimes call features. Interest rates are one important driver of bond prices, not the only driver.
One GMS Insight: A Fixed Promise in a Changing Market
A bond is a fixed promise traded in a changing market. The scheduled payments may stay the same, but the price investors will pay for them changes when the return available elsewhere changes. The inverse price–yield relationship is the market repricing old cash flows against new opportunities.
What to Watch
Comparable market yield: the return investors now require on similar bonds.
Coupon rate: the existing fixed payment relative to face value.
Remaining maturity and duration: how sensitive the price is to a yield change.
Credit and liquidity: additional influences, especially for non-Treasury bonds.
The Bottom Line
When comparable market yields rise, an existing fixed-rate bond cannot increase its promised coupon. Its market price falls until its unchanged future payments offer a competitive yield to a new buyer. Bond coupons are fixed. Market-required returns are not.