Why Existing Government Bond Prices Fall When Yields Rise
Understand the inverse relationship between government bond prices and market yields by discounting fixed cash flows. Distinguish coupon rates, yield to maturity, and realized returns, and examine maturity and currency risks.
If an existing fixed-rate government bond’s principal and interest payments are unchanged, a higher required market yield reduces the present value of those cash flows. Bond prices and yields therefore generally move in opposite directions. The coupon rate sets contractual payments, while market rates and yield to maturity relate to the current price; distinguish them.
The price you pay matters more than the coupon rate alone
Paying more for a bond with fixed interest on its face value increases the initial investment relative to the cash received, lowering the yield. Paying less has the opposite effect. When comparing bond prices, also check the difference between the quoted price and the actual settlement amount including accrued interest. Yield to maturity is the discount rate linking scheduled cash flows to price; it does not unconditionally guarantee a future holding-period return. The rate earned on reinvested coupons and, if the bond is sold before maturity, its market sale price affect the final result.
Longer maturities can be more sensitive to rate changes
The larger the share of cash received far in the future, the greater the impact of a change in discount rates tends to be. Compare maturity and duration together for otherwise similar bonds. Modified duration provides a useful approximation of price changes for small yield moves, but errors can grow for larger moves. The assumption that yields at all maturities move equally can also differ from actual yield-curve behavior. A central bank cut in short-term policy rates does not guarantee an equal decline in long-term government bond yields.
Distinguish holding to maturity from needing cash earlier
If the issuer pays as promised, a decline in market price alone does not change an individual fixed-rate bond’s scheduled principal and interest. However, selling early to raise cash can realize a loss, and inflation reduces the purchasing power of the proceeds. For foreign-currency government bonds, the won value changes even when payments are received in the bond’s currency. Also distinguish a bond fund that continually replaces maturing holdings from an individual bond repaid on a specified date. Government issuance does not eliminate all credit, liquidity, and currency risks.
Worked example
Hypothetical example: Assume a bond pays KRW 1,000 exactly 1 year from now and no interim interest. At a required annual yield of 5%, its price is 1,000 ÷ 1.05, or approximately KRW 952.38. At the same point in time, a 6% yield gives a price of 1,000 ÷ 1.06, or approximately KRW 943.40. The price falls approximately 0.94%. Only the yield changes in this example, with no passage of time, credit changes, or costs. A 1-percentage-point rise in yield does not always equal a 1% decline in bond price.
What to check
- Have you distinguished the coupon rate from the current yield to maturity?
- Have you checked accrued interest in the difference between the quoted price and settlement amount?
- Have you examined remaining maturity and duration together?
- Have you reviewed early-sale, inflation, and foreign-currency conversion risks?
Sources and primary materials
This is educational material about research methods. For an actual company decision, verify the filings and primary sources for the relevant period.