Why Bond Prices And Yields Move Oppositely

Bond commentary constantly pairs falling prices with rising yields, which sounds like two events. It is one event described from two directions, and the arithmetic is simple.

The payments are fixed at issue

A conventional bond specifies the amounts it will pay and the dates it will pay them. Those terms do not change once the bond exists.

What can change is the price someone pays to acquire that stream of payments. The bond trades in a market where prices adjust continuously.

Since the payments are fixed, a lower purchase price means a higher return for the buyer. That is the entire relationship.

Yield expresses return relative to price

The simplest measure divides the annual payment by the price. Paying less for the same payment produces a larger figure.

Yield to maturity extends this by including the difference between the price paid and the amount repaid at maturity, spread over the remaining term.

Both measures are derived from the price rather than being set independently, so a price change necessarily produces a yield change in the opposite direction.

New issues drive existing prices

When prevailing rates rise, newly issued bonds offer larger payments. An existing bond paying less becomes less attractive at its current price.

Its price falls until the return available from buying it matches what the new bonds offer, adjusted for term and credit quality.

Nothing about the existing bond has deteriorated. It has simply been repriced to stay competitive with the alternatives now available.

Term amplifies the effect

A bond maturing shortly repays face value soon, so its price cannot move far from that value regardless of rate changes.

A bond maturing in decades has many payments affected by the change in discount rate, so the same shift in rates produces a much larger price movement.

This is why long-dated bonds move so much more than short-dated ones on identical news about interest rates.

Credit concerns work through the same channel

If a borrower's ability to repay is questioned, buyers require a higher return to hold the bond, which they obtain by paying a lower price.

The yield rises for a different reason than a rate change, but the mechanism connecting price and yield is identical.

Separating the two components matters, because a yield rise driven by rate expectations and one driven by credit concerns imply very different things about the issuer.