How do interest rate risks affect bond trading?

In the context of bond trading, the relationship between bond prices and interest rates is fundamental to understanding how interest rate risks affect the market. When interest rates rise, newly issued bonds enter the market with higher yields to attract investors. As a result, existing bonds, which pay lower interest rates, become less attractive. Consequently, to entice buyers in a market where new options are offering better returns, the prices of existing bonds must decrease.

This inverse relationship is a crucial concept for traders and investors. When interest rates go up, bond prices fall, meaning that an investor holding a bond may experience a loss if they decide to sell it before maturity. Thus, the price adjustment reflects the market's realignment with the prevailing interest rates, enabling investors to make informed trading decisions based on anticipated changes in rate environments.

Understanding this dynamic is essential for anyone involved in bond trading, as interest rate fluctuations are one of the primary factors influencing bond valuation and investment strategy.