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I feel as if I'm missing a fundamental step here. I'm aware that bond prices fall as yields go up; but what makes yields go up?

If I had a bond issued in the UK for example, and the base rate went up by 0.5%, would that mean the yield of the bond has to go up by 0.5%?

I'm a little confused as to what's driving the yield to maturity to change?

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  • There are different kinds of bonds. Can you be more specific?
    – Philipp
    Apr 14, 2019 at 21:52
  • Any really, a bullet bond for example?
    – Simon Nicholls
    Apr 14, 2019 at 22:50

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Suppose you buy a $1,000 bond that pays 4% per year ($40). Interest rates then rise to 5% and the same quality bond (new issue) now pays $50 per year. Why would anyone buy your bond for $1000 that only pays $40 per year? To compensate, your bond must drop in price to $800 to provide a 5% yield. That's the simple mechanics of it.

In reality, it's not that simple. Other factors modestly affect the amount in bond price change (type of bond, quality, duration, special features, etc.).

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  • What interest rates rise though, is it just the base rate?
    – Simon Nicholls
    Apr 14, 2019 at 22:14
  • In the US, there are short term rates (Fed funds) as well as intermediate and long term rates. If you have a 5 year bond, it's not likely to react much to short term rate changes and if it briefly does so, it's likely to correct back in line. It will react more closely to changes in the 5 year interest rate.
    – Bob Baerker
    Apr 14, 2019 at 22:56
  • Your example is not completely accurate as the rate that you're matching is not the coupon, but the yield to maturity. I'd use a zero coupon bond as a more accurate but still simple example. I.e. Paid $822 for a $1000 bond maturing in 5 years (4% yield). Yields rise to 5%, so now the bond is worth $784 (5% yield).
    – Earth
    Apr 15, 2019 at 19:19

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