Why Bonds Change In Price

If it is issued close to par ($100), the coupon on fixed income investment reflects prevailing interest rates at time of issuance. For example, the Government of Canada has several bond issues due in 2001. The coupons on these Canada bonds range between 6% and 12%, reflecting the interest rates at their respective time of issue.

When bonds are traded on the secondary market, their price reflects the level of their coupon compared to the current interest rate for a similar bond. Assuming the interest rate on a new Government of Canada (Canada) maturing mid 2001 is 6.5%, an existing Canada issue of similar term paying 9.75%, or $9.75 on its $100 principal amount, is clearly worth more than $100. If you do the mathematics, they will tell you that the 9.75% Canada bond is worth about $113. The reverse is true as well, if the current interest rate on a new Canada bond is 9.75% and an existing Canada bond has a coupon of 6.5%, an investor can receive $9.75 for investing $100 in the new bond compared to $6.50 in the old Canada bond. The price of the 6.5% Canada bond will clearly fall until it provides the same 9.75% rate as a new bond. This would mean a fall in price of around $12.

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