What happens to the price of a bond if interest rates decrease?

When interest rates decrease, the price of existing bonds tends to increase. This is because there is an inverse relationship between bond prices and interest rates. When new bonds are issued at lower interest rates, the older bonds that offer higher interest rates become more attractive to investors. Consequently, demand for these older bonds increases, driving up their price in the market.

As investors seek higher yields in comparison to the lower rates available on new issues, the existing bonds with their higher interest payments gain value. This mechanism reflects the fundamental principle of supply and demand in financial markets, where the prices are directly affected by changes in interest rates. Thus, when interest rates drop, the increased attractiveness of older bonds leads to an increase in their market price.