How does the value of bonds react when interest rates fall?

When interest rates fall, the value of existing bonds typically goes up. This increase is driven by the inverse relationship between interest rates and bond prices. When new bonds are issued at lower interest rates, the existing bonds that were issued at higher rates become more attractive to investors since they offer more favorable returns. Consequently, investors are willing to pay more for these existing bonds, driving their market value higher.

That contrast is crucial to understand. As rates go down, the fixed interest payments from existing bonds become relatively more valuable. Additionally, bond markets adjust to this change in interest rates, with demand increasing for the higher-yielding bonds, further amplifying the increase in their prices. This inverse relationship between interest rates and bond prices is a fundamental concept in fixed-income investing, well-recognized by investors and finance professionals alike.