Interest Rates Affect Bond Prices

In short, interest rates and bonds work like a seesaw: When rates rise, bond prices tend to fall, and when rates fall, bond prices tend to rise. If interest rates rise, newly issued bonds will pay higher interest than the bonds you own. Typically, your older bonds will be worth less, and you'd have to sell them at a discount. If, however, interest rates drop, newly issued bonds will pay lower interest than the bonds you own. Then your older bonds will be typically worth more, and you'd be able to sell them at a higher price.

Interest rates can also influence an issuer's decision to pay off the bonds early. Just as you can pay off a mortgage at any time without a penalty, many bond issuers have the ability to redeem - or call - in a bond before its date of maturity. Typically, if interest rates drop significantly, a "callable" bond will get redeemed early by the issuer. This allows the bond issuer to refinance the debt at a lower interest rate.

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