Canadian Securities Course (CSC) Level 1 Practice Exam

Describe the relationship between bonds prices and interest rates.

1. They move in the same direction

2. They have no relationship

3. They move inversely

4. They are unaffected by interest rates

The correct answer is: They move inversely

The relationship between bond prices and interest rates is indeed inverse. When interest rates rise, existing bond prices typically fall. This occurs because new bonds are issued at the higher prevailing interest rates, making older bonds with lower rates less attractive. Investors seeking the best returns will prefer the newer bonds, which leads to a decrease in demand—and thus price—for the older bonds. Conversely, when interest rates fall, existing bond prices rise, as those older bonds now offer yields higher than the new issues, increasing their market value. This inverse relationship is a fundamental principle in fixed income investments and is crucial for understanding bond market dynamics. Alternatives that suggest a direct movement, no relationship, or being unaffected by interest rates do not accurately reflect how bond markets operate and lack the understanding needed to navigate investments in bonds effectively.