If a bond carries a 6.5% interest rate, and interest rates in the market rise to...
- If a bond carries a 6.5% interest rate, and interest rates in the market rise to 9%, what happens to the market price that bond trades at all other things being equal?
Homework Answers
Interest rate risk arises due to changes in market interest rate. This primarily affects fixed income securities because bond prices are inversely related to market interest rate. An interest in market interest rate causes bond prices to fall and vice versa.
Hence, here when the interest rate in the market rises to 9%, and the bond interest rate is still 6.5% then we will not find any buyer for this bond because in market the interest rate is 9% , therefore this bond will be attractive only at a price lower than the current price. Thus, the market price of the bond will decrease. This is the 'Price Risk' component of the interest rate risk.
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