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According to the following article:

Bonds offering lower coupon rates generally will have higher interest rate risk than similar bonds that offer higher coupon rates.

And:

For example, imagine one bond that has a coupon rate of 2% while another bond has a coupon rate of 4%. All other features of the two bonds [...] are the same. If market interest rates rise, then the price of the bond with the 2% coupon rate will fall more than that of the bond with the 4% coupon rate.

Why the price of the bond #1 should fall more?

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The key concept here is called Yield To Maturity (YTM). This is the yield that bond has when held until its redemption date. It is calculated from the coupon and the price the bond trades at today. (Which may not be face.) What happens is that as interest rates rise and fall, the price that a bond will buy or sell for adjusts so that the YTM matches the current YTM of new similar bonds.

Let's look at an example using some simple numbers. Suppose that we have two treasury bonds that have 5 years left on them. (They were issued at different times with different maturities.) One pays 4%, one pays 2%. Now suppose that the yield of newly issued 5 years treasuries is 5%. What will happen? The price of the two bonds will adjust down until the effective yield based on the price the bond trades for is 5%. The price of the 4% bond will have to fall by about 4.5% of face, and the price of the 2% will fall by about 13% of face.

It's always good remember that bond prices and interest rates are on a seesaw. As rates go up, price of existing bonds go down and vice versa.

  • Don't you need to address the rate and prices before the rate changes to 5%? – DJohnM Jan 19 '17 at 5:25
  • It will be +1 if you fix the typos. Please re-read what you wrote for values the bonds will drop. 25%/60% can't be correct. – JTP - Apologise to Monica Jan 19 '17 at 11:04
  • @JoeTaxpayer I went to the investing answers Yield To Maturity calculator and tried some different inputs. For a $1000 face bond, paying 2% coupon paid quarterly, the price has to be $868 to get a 5.00% YTM. You are correct it isn't 60% off of face, so I will update the answer with better number – zeta-band Jan 20 '17 at 17:11
  • You got it. The new numbers are good, and hopefully OP understands the math behind the numbers. – JTP - Apologise to Monica Jan 20 '17 at 17:43
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    No harm done! I've read some answers the next day, and vowed never to "drink and answer" again.... I'll revisit, and if Zeta hasn't updated, I can edit. Either way, I'll clean up these comments. – JTP - Apologise to Monica Jan 21 '17 at 21:31

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