Did you know that bond prices and yields move in opposite directions It’s one of the most important principles in fixed income investing. Let’s understand how this works and why it matters. Imagine a bond priced at Rs 100, offering an annual interest of 6 percent on its face value. Now, assume market interest rates rise and a new bond is issued at the same face value of Rs 100, but offering 7 percent annual interest.

Naturally, investors will prefer Bond B with 7 percent interest. While the demand for the older Bond A with 6 percent interest declines, and so does its price. But how do these price changes impact the yield. Let’s look at the numbers.

For Bond A, the price dropped from Rs 100 to Rs 99, but it still pays 6 percent as annual interest.  So, the yield for this bond which was 6 percent earlier now rises to 6.1 percent for new buyers.

Here we saw that when interest rates went up from 6 percent to 7 percent, the price of Bond A fell from Rs 100 to Rs 99.

In another instance, rising interest rates increased the demand for Bond B which in turn raised its price from Rs 100 to Rs 101. While it pays 7 percent annual interest, the yield for new buyers is now only 6.9 percent. In this case we saw that yield falls when bond price goes up.

In both these examples we noticed that bond price and bond yield move in opposite directions or are inversely corelated.

This is the essence of the inverse relationship, when bond price rises, yield falls. When bond price falls, yield rises. Understanding this relationship is crucial when evaluating bonds in a changing interest rate environment.

Whether you're building a debt fund portfolio or investing directly in bonds, keep this principle in mind.