Finance, Forex and Investments

Why does an interest in buying bonds cause interest rates to fall?

I read in the New York Times today that more people are buying bonds than before, and this is causing interest rates to fall. Why does an interest in buying bonds drive down interest rates?

Public Comments

1. Because people are willing to pay less for bonds. Things are so crazy - that if the government were to offer 1% 30 year bonds, people would probably buy them STILL. Supply and demand. The goverment can sell these bonds for nothing due to the high demand. People will still buy them. /
2. Bond prices move in the opposite direction of interest rates.
3. Bond prices move inversely to interest rates. When interest rates go up, bond prices go down and when interest rates go down, bond prices go up. Remember, we’re talking about previously issued bonds trading on the open market. You can more easily understand this by looking at the following example. A bond is issued for $10,000 for five years with a 5% coupon or interest rate, paid every six months. Then interest rates rise to 6%. If you want to sell this bond, who would buy it when it is paying 1% below market rates (5% vs. 6%)? You have to sweeten the deal so the buyer gets a market rate for the bond. You can’t change the interest rate on the bond. That’s fixed at 5%. You can, however change the price you will take for the bond. The annual payment of $500 ($10,000 x 5%) must equal a 6% payment. Doing the math, you discover that the face value of the bond must be discounted to $8,333 so that the $500 fixed payment equals a 6% yield on the buyer’s investment ($8,333 x 6% = $500). If interest rates went down instead of up, you could then sell your bond at a premium over face value because the fixed interest rate would be higher than the market rate.