A bond is a type of loan made by an investor to a company or government. In return, the borrower typically pays interest and agrees to repay the bond's face value at a specified maturity date, subject to the bond's terms and the borrower's ability to pay.

Why do bond prices fall when interest rates rise?

When interest rates rise, newly issued bonds may offer higher returns than existing bonds with lower fixed coupon payments. Investors are therefore generally willing to pay less for existing bonds, causing their market prices to fall.

Why do bond prices rise when interest rates fall?

When interest rates fall, existing bonds with higher fixed coupon payments become more attractive than newly issued bonds offering lower rates. Investors may be willing to pay more for existing bonds, causing their market prices to rise.

Can you lose money on a bond if the company keeps paying interest?

Yes. A bond's market price can fall when interest rates rise, even if the company continues to pay interest on time. An investor who sells the bond before maturity may receive less than they paid. Credit risk, inflation and other factors can also affect investment returns.

What happens if you hold a bond until maturity?

If an investor holds an individual bond until maturity and the issuer meets its obligations, the investor receives the contractual interest payments and the bond's face value at maturity. The market price may fluctuate in the meantime, and inflation can reduce the purchasing power of the money received.

Are bonds safer than shares?

Bonds and shares have different risks. Bondholders generally rank ahead of shareholders when a company is wound up, but bonds can still lose market value and issuers can default. The level of risk depends on the issuer, the bond's terms, interest rates and other factors.

Are bond funds the same as individual bonds?

No. An individual bond usually has a specified maturity date when its face value is due to be repaid, subject to the issuer meeting its obligations. A bond fund holds a portfolio of bonds and may continually buy and sell them. A typical bond fund does not promise to return an investor's original investment on a specific date.

Are longer-term bonds more sensitive to interest rate changes?

Generally, yes. Bonds with longer durations tend to experience larger price changes when market interest rates change. Duration is a measure of a bond's sensitivity to interest rates and depends on factors including its maturity and coupon payments.

How to Teach Your Kids about Bond Prices

Will Rainey

Oct 24

7 min read

A few years ago, I wrote a blog explaining how to teach your kids about bonds. Using the example of Subway wanting to sell sandwiches on Mars, I explained how companies borrow money from investors, why investors buy bonds, and how bonds differ from shares in a company.

If you haven't read it yet, you can find it here: How to Teach Your Kids About Bonds.

At the end of that blog, I promised to explain something a little more complicated:

Why do bond prices go down when interest rates go up, and vice versa?

It's a question that confuses plenty of adults, let alone children!

But once you understand the logic, it's actually quite straightforward. And it provides a great opportunity to teach children about interest rates, the value of money and how financial markets work.

Let's recap on our imaginary Subway adventure on Mars from the first blog.

Part 1: You own a bond. What happens next?

In the original blog, we imagined Subway wanted to borrow money to build restaurants on Mars.

To raise the money, Subway offered a deal:

You lend Subway $100.
Subway pays you $4 every year (4% interest)
After five years, Subway returns your original $100.

In financial language, the $100 is the bond's face value, the $4 annual payment is the coupon, and the five years is the term.

Let's assume Subway is doing well on Mars. Its restaurants are busy, the sandwiches are selling, and it continues to make all its interest payments on time.

So far, so good!

But now imagine that you need your $100 back before the five years are up.

Can you get your money back?

Fortunately, you don't have to wait for Subway to repay you. You can try to sell your bond to someone else.

This is what happens in the bond market. Investors buy and sell bonds that have already

been issued, just as investors buy and sell shares in companies.

But there's a catch.

The person buying your bond doesn't necessarily have to pay you $100.

They'll decide how much it's worth to them. And one of the biggest factors influencing that decision is the interest rate they could earn elsewhere.

Let's see why.

Part 2: What if interest rates go UP?

Imagine that a year has passed since you bought your Subway bond.

You still have a bond that will pay you $4 at the end of each year and return your $100 after 4 years (as a year has passed).

However, something has changed.

Interest rates have increased. If you lend money to a similar company today, you can now earn 6% interest rather than the 4% your Subway bond pays you.

You decide you'd like to sell your Subway bond.

I asked my daughters:

"If I had $100 to invest. Would I rather buy a new bond that pays me 6% interest, or buy your Subway bond that only pays me 4%?"

The answer seems obvious. Why would I choose the bond paying less interest?

Exactly!

The 6% bond over that 4 years would pay $6 per year plus $100 back at the end. That would be approximately $124. A return of $24 on my $100 investment over the 4 years.

Your 4% Subway bond would pay $4 per year plus $100 back at the end. That would be approximately $116 after 4 years. A return of $16 on my $100 investment over 4 years. That's $8 less than the $24 return from the new 6% bond!!

If you want to find a buyer for the Subway bond, you'd need to reduce the price you would sell it for to make it more attractive to buyers. You could offer to sell the Subway bond for $92, rather than $100.

Now the deal starts to look more interesting.

I would pay you approximately $92. I'd still get $4 per year and $100 back after 4 years. That means I get a total on $116 from my $92 investment. A return of $24 over 4 years which is very similar to the return on the 6% bond.

So, although Subway is still making all its payments on time, the price of your Subway bond has fallen because interest rates have increased.

The bond's price has adjusted to make it competitive with the returns available on new bonds.

This is the key lesson:

When interest rates rise, the price of an existing fixed-rate bond generally falls.

Bond prices fall when interest rates increase

Note: The maths for the exact change in the bond price isn't quite this simple as the above in real life! The price depends on when the interest payments are received and how long it is until the original loan is repaid. But the principle remains the same: When interest rates fall, existing bond prices generally increase.

The bond hasn't changed. Subway still pays the same $4 interest. What's changed is what investors can earn elsewhere.

Part 3: What if interest rates go DOWN?

Let's rewind and imagine the opposite happens.

Instead of rising to 6%, interest rates fall to 2%.

New bonds now offer investors just $2 a year for every $100 invested.

Over 4 years, I'd get $8 in coupons ($2 per year) and the original $100 back. That would be $108 after 4 years, broadly equivalent to a return of $8 on my $100 investment over 4 years.

Suddenly, your Subway bond looks rather attractive as I'd get a return of $16 on my $100 after 4 years.

If you want to sell your Subway bond, other investors should be willing to pay more than $100 for it.

How much would the price change for me to be willing to sell?

If you sold your bond for $100 and bought a new 2% bond, you would lose $8 ($116 from your bond minus $108 from the new 2% bond). Therefore, you would want to sell for your bond for at least $108, rather than $100, to offset that potential loss.

The buyer pays more than $100 today but still makes $8 return after 4 years, which is competitive with other bonds on the market.

Once again, the price adjusts to reflect the interest rates available elsewhere.

When interest rates fall, the price of an existing fixed-rate bond generally rises.

Link between interest rates and bond prices

You can think of it as a seesaw. When one side goes up, the other goes down.

Market interest rates	Existing fixed-rate bond prices
Rise	Generally fall
Fall	Generally rise

These are general relationships. Other factors, including the risk of the borrower failing to repay, can also affect a bond's price.

The longer the term of the bond, the more the price changes when interest rates change. This is sensible as there are more years where the interest on your bond paying a fixed coupon is different from what is available in the market.

Part 4: Why does this matter to investors?

You might be wondering why any of this matters.

After all, if Subway continues to pay you $4 a year and returns your $100 after five years, why should you care what someone else would pay for your bond today?

That's a fair question.

The answer depends on what you plan to do with your investment.

If you hold the bond until it matures

Assuming Subway doesn't default (i.e., can't afford to pay back the money), and the bond's terms remain unchanged, you continue to receive your promised interest and get your $100 face value back at maturity.

The fact that someone might only pay you $92 for your bond today doesn't change those contractual payments.

Of course, inflation means that the $100 you receive in five years may buy less than $100 buys today.

If you want to sell the bond early

Now the price matters a great deal.

If interest rates have risen, you may have to sell your bond for less than you originally paid.

If interest rates have fallen, you may be able to sell it for more.

And this is why bonds are not always as predictable as people assume. Even when a borrower is reliable, changes in interest rates can affect the value of an investment.

There's an important distinction here, too. An individual bond with a specified maturity date is different from a bond fund, which owns many bonds and continually buys and sells them.

A bond fund doesn't have one maturity date when all investors are guaranteed to receive their original investment back.

Part 5: Can you use this to make money?

Let's imagine you believe interest rates are going to fall.

You might decide to buy bonds today, hoping their prices will rise when interest rates fall. If that happens, you could potentially sell your bonds for a profit.

Equally, if you believe interest rates are going to rise, you might expect existing bond prices to fall.

Sounds simple, doesn't it?

Unfortunately, it's not quite that easy.

First, you need to be right about what happens to interest rates. Second, bond prices are influenced by more than just interest rates. Third, even if rates move as you expect, the change may already be reflected in bond prices.

And remember that longer-term bonds are generally more sensitive to interest-rate changes than otherwise similar shorter-term bonds.

This is one reason I don't encourage children to think of investing as a way to predict what markets will do next.

Instead, I'd rather they understand the principles, appreciate the risks and develop sensible long-term habits.

You don't need to predict interest rates to understand why bonds exist or how they can fit into a diversified investment portfolio.

Summary: Three things to remember

If you take just three lessons away from this blog, make them these:

Bonds can be bought and sold. If you want your money back before a bond matures, you may be able to sell it to another investor, but the price could be higher or lower than you paid.
Interest rates and existing fixed-rate bond prices generally move in opposite directions. When interest rates rise, prices tend to fall. When interest rates fall, prices tend to rise.
A bond's price can change even if the borrower continues to pay its interest on time. The price reflects what other investors are willing to pay, based partly on the returns available elsewhere.

I love teaching children about topics like this because they show that money isn't just about saving, spending or investing. It's also about understanding how the world works.

And you don't need to be an actuary to explain it to your children!

You just need a simple example, a few questions and, if you're anything like me, a slightly ridiculous story about selling sandwiches on Mars.

👉 What to read next: How to teach your kids about the Greater Fool Theory

Thanks for reading!

Will

P.S., Teaching your kids about money can give them such an advantage in life. To help them learn about money through stories, grab them a copy of Grandpa's Fortune Fables or Frankie Fortune. Available on Amazon.