Examkin

Question

Difficulty: EasyDebt Securities and Bond Structure

When prevailing interest rates in the financial markets increase, what generally happens to the market price of existing fixed-rate bonds in the secondary market?

  1. The market price decreases.Answer
  2. B
    The market price increases.
  3. C
    The market price remains unaffected because the coupon rate is fixed.
  4. D
    The market price remains unchanged because the par value adjusts upward.

Answer

The market price of existing fixed-rate bonds decreases.
Bond prices and interest rates have an inverse relationship. When prevailing market rates rise, newly issued bonds offer higher coupon payments, causing existing lower-coupon bonds to drop in market price to provide a competitive yield to buyers.

Step-by-Step Solution

1
Identify the core relationship between market interest rates and bond prices.
Bond prices and interest rates share an inverse relationship.
Existing fixed-rate bonds must adjust in market price to compete with newly issued bonds paying higher rates.
2
Apply the interest rate increase scenario to existing secondary market bonds.
The secondary market price decreases.
Investors demand a price discount on lower-yielding existing bonds to match prevailing market yield expectations.

Key Concept

Inverse relationship between interest rates and bond prices
Rate this question

Topics

Debt Securities and Bond Structure

More questions from this topic