Bond Yields, Prices, and Interest Rate Relationships

Bond yield questions test whether you understand that a bond’s stated coupon is fixed, but the market price is not. Once the price moves, the bond’s effective yield to a new buyer changes. The single most important relationship is that bond prices and market yields move in opposite directions.

Coupon Rate Versus Market Yield

The coupon rate is fixed in the bond terms. Market yield is what investors demand now for comparable risk and maturity. If a bond’s coupon is more attractive than current market rates, investors may bid the bond above par. If the coupon is less attractive than current market rates, the bond may trade below par.

That is why coupon rate and yield should never be treated as interchangeable terms.

Current Yield and Yield to Maturity

Two common yield concepts are:

• Current yield: annual coupon income divided by current market price
• Yield to maturity: a broader measure that reflects coupon payments, time to maturity, and the difference between purchase price and par value if held to maturity

Current yield is faster and more limited. Yield to maturity is more comprehensive.

    flowchart LR
	    A["Market rates rise"] --> B["Existing bond prices fall"]
	    C["Market rates fall"] --> D["Existing bond prices rise"]
	    E["Price change"] --> F["Yield for new buyer changes inversely"]

Premium and Discount Logic

If a bond trades at a premium, its coupon rate is generally above the yield required by the market for that bond’s risk profile. If it trades at a discount, its coupon rate is generally below the required market yield.

This relationship is tested constantly. The clean exam shortcut is:

• premium bond -> coupon above current market yield
• discount bond -> coupon below current market yield

Maturity and Price Sensitivity

Longer maturities usually mean greater sensitivity to interest-rate changes, all else equal. A long-term bond has more future cash flows exposed to changing discount rates, so its price often moves more when rates shift.

That does not mean every long bond is automatically unsuitable. It means time horizon and rate sensitivity matter in fixed-income suitability.

Key Takeaways

• Bond prices and yields move inversely.
• Coupon rate is fixed; market yield changes as price changes.
• Current yield is narrower than yield to maturity.
• Longer maturities generally involve greater price sensitivity to rate changes.

Sample Exam Question

An investor owns a bond with a 3% coupon. Comparable new bonds are now being issued at 5%. Which statement is most accurate about the older bond?

A. Its market price will generally rise above par. B. Its market price will generally fall below par. C. Its coupon rate will reset to 5%. D. Its par value will increase so its yield matches the market.

Correct Answer: B

Explanation: If comparable new bonds offer higher yields, an older lower-coupon bond is generally less attractive and must fall in price to compete.

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