SIE Exam Question 38: Answer and Explanation

Question: 38

When interest rates increase, what happens to bond prices?

• A. Bond prices increase
• B. Bond prices decrease
• C. Bond prices may increase or decrease
• D. Changes in interest rate have no effect on bond prices

Correct Answer: B

Explanation:

When interest rates increase, bond prices decrease. Bonds have an inverse relationship to interest rates. Most bonds pay a fixed interest rate that becomes more attractive if interest rates fall as there will be more investor demand that will drive up the price of the bond. Conversely, if interest rates rise, investors will no longer prefer the lower fixed interest rate paid by a bond, resulting in a decline in the price of the bond.