Hi, Please could someone explain to me why bond prices rise if interest rates fall? I would have thought that a rise in interest rates would cause the coupon payments to be bigger, pushing demand for (and hence the price of) the bond up. Thanks
Yes it does seem somewhat counter intuitive, but you must remember for fixed interest securities like government bonds, the coupon rate is not variable with interest rates; it is fixed at the outset. So if interest rates fall, this means that the future coupon payments will be discounted at a lower interest rate, and result in a higher price (If you have done or are doing CT1 check out the chapter 14 i believe it is - The term structure of interest rates to see how this works mathematically)
