Reference no: EM133068531

Bonds and interest rates have an inverse connection. Bond prices normally fall when the cost of borrowing money rises (interest rates rise). Similarly, as interest rates fall, the bond price rises. The negative correlation between interest rates and bond prices appears odd at first look. Closer investigation, however, reveals that it actually makes logic.

Most bonds pay a set interest rate that rises in value when interest rates fall, increasing demand and raising the bond's price. If interest rates rise, investors will no longer favor the lower fixed interest rate offered by a bond, causing its price to fall. In practice, zero-coupon bonds are a good example of how this mechanism operates.

Are US bonds in a tricky place due to global dynamics?