Financial Assets and Bond Prices

A bond is a loan you made to a government or company. It promises to pay you a fixed dollar amount each year, no matter what else happens in the economy. That fixed payment is the whole story. If interest rates rise after you bought your bond, brand new bonds start offering bigger payments for the same price. Nobody will pay full price for your old, lower-paying bond anymore, so its price has to fall until its fixed payment looks competitive. If interest rates fall, the opposite happens: your old bond's payment now looks generous, so people bid its price up.

This gives a direct, inverse relationship between bond price and interest rate (yield). The current yield is just the annual payment divided by the price, times 100 to express it as a percent. Push the price down and that same dollar payment is now a bigger share of a smaller number, so the yield rises. Push the price up and the yield falls. Price and yield are two ways of describing the same bond, moving in opposite directions.

This matters beyond individual bonds. When a central bank buys bonds on the open market, it drives bond prices up across the market, which pushes interest rates down economy-wide. That connects directly to the next idea, the money market, where the central bank's actions shift the supply of money and set the nominal interest rate that all these bond yields track.