Why do bonds fall when interest rates rise?

📘 Brief Explanation

Bonds pay a fixed interest coupon that remains constant over their term. When market interest rates rise, newly issued bonds with higher coupons become more attractive. Existing bonds with lower coupons therefore lose value, as investors would only buy them at a discount. This price decline compensates for the yield difference, so that the total return until maturity once again matches the current market level. The longer the remaining term of a bond, the more its price falls when interest rates rise.

🔍 Why This Matters

The relevance stems from the direct loss in value of existing bond holdings in a private portfolio when interest rates rise, which often leads to unexpected losses. Many retail investors confuse the price movement of bonds with that of a fixed-term deposit and underestimate interest rate risk. Additionally, the inverse relationship between price and yield significantly influences decisions about the right time to buy or sell. Without this understanding, mistakes can occur when reallocating portfolios or choosing maturities. Knowledge of this mechanism is therefore essential for realistic yield expectations and managing one’s own investment risk.