Chapter 2 of 4

Why interest rates move bond prices

8 min read

Bond prices and interest rates move in opposite directions. Understanding why makes debt funds much easier to read.

The idea

Suppose you hold a bond paying 8%, and market rates rise so new bonds pay 9%. Nobody will pay full price for your 8% bond, so its price must fall until its yield matches the market. If rates fall, the reverse happens.

Same bond, different maturity (₹1,000 face value, 8% coupon)

If market yields rise from 8% to 9%, a 2-year bond falls from ₹1,000 to about ₹982, a drop of roughly 1.8%.
A 10-year bond falls from ₹1,000 to about ₹936, a drop of roughly 6.4%.
Same rate move, much bigger price effect for the longer bond.

Duration

Duration is a measure of a bond's or fund's sensitivity to interest-rate changes, expressed in years. As a rough guide, a fund with a duration of 5 years may fall about 5% if yields rise by one percentage point, and rise by about the same if they fall.

Short-duration funds are less sensitive to rate moves.
Long-duration and gilt funds can swing sharply when rate expectations change.
Your holding period should be at least as long as the fund's duration.

Reinvestment

Rising rates hurt existing holdings in the short run but allow new money to be invested at higher yields. That is why a hold or a rate cut can help bond prices, while a hike generally hurts them.

Key takeaways

When rates rise, existing bond prices fall; when rates fall, they rise.
Longer maturity and higher duration mean bigger price swings.
Match a debt fund's duration to your investment horizon.

This content is for education only and is not investment or tax advice. Mutual fund investments are subject to market risks; read all scheme-related documents carefully.