Western Governors University (WGU) FINC6000 C214 Financial Management Practice Exam

When market interest rates rise, the price of existing bonds typically decreases. This relationship is rooted in the mechanics of bond valuation. Bonds pay fixed interest payments, and when market interest rates increase, new bonds are issued that offer higher yields. As a result, existing bonds with lower interest payments become less attractive to investors, leading to a decline in their market price. For example, consider an existing bond that pays a fixed interest rate of 5%. If new bonds are issued at a 7% interest rate, investors will seek the new bonds for their better returns. Consequently, the price of the existing bond must drop to offer an equivalent yield that competes with the new market rates; this adjustment ensures that the existing bond remains appealing. Understanding this fundamental principle helps clarify why the correct answer aligns with the premise of bond investment and market behavior. Thus, as market interest rates rise, the value of existing bonds falls, resulting in a decrease in their price.