What effect does an increase in interest rates typically have on bond prices?

An increase in interest rates typically leads to a decrease in bond prices due to the inverse relationship between interest rates and bond prices. When interest rates rise, new bonds are issued with higher yields to attract investors. Existing bonds, which were issued at lower rates, become less attractive because they offer lower returns compared to the new bonds. As a result, the price of existing bonds must adjust downward to offer a yield that is competitive with newer issues.

This adjustment reflects investors' willingness to sell existing bonds at lower prices in order to purchase new issues that offer better returns. Consequently, as interest rates climb, bond prices decline, illustrating the fundamental principle of fixed-income investing that is critical for understanding the dynamics of debt markets.