If market interest rates decline, what happens to the yield-to-maturity of bonds?

If market interest rates decline, what happens to the yield-to-maturity of bonds?

• A. Yields will increase
• B. Yields will remain the same
• C. Yields will decline
• D. Yields will become unpredictable

Answer: (C)

When market interest rates decline, the yield-to-maturity (YTM) of existing bonds also decreases. This relationship exists because the YTM reflects the total return an investor can expect if the bond is held to maturity, taking into account the bond’s current market price, interest payments (coupon payments), and the time until maturity. As market rates fall, newly issued bonds will generally offer lower coupon rates. Thus, existing bonds, which may have been issued with higher coupon rates, become more attractive to investors. These existing bonds will trade at higher prices in the market, which inversely affects their yield-to-maturity. Since yield is calculated based on the bond's annual interest payments relative to its current market price, when the price of the bond goes up due to decreased market interest rates, its yield-to-maturity falls. Therefore, when market interest rates decline, the yields on existing bonds decline as well, making the chosen answer the correct one.

When market interest rates decline, the yield-to-maturity (YTM) of existing bonds also decreases. This relationship exists because the YTM reflects the total return an investor can expect if the bond is held to maturity, taking into account the bond’s current market price, interest payments (coupon payments), and the time until maturity.

As market rates fall, newly issued bonds will generally offer lower coupon rates. Thus, existing bonds, which may have been issued with higher coupon rates, become more attractive to investors. These existing bonds will trade at higher prices in the market, which inversely affects their yield-to-maturity. Since yield is calculated based on the bond's annual interest payments relative to its current market price, when the price of the bond goes up due to decreased market interest rates, its yield-to-maturity falls.

Therefore, when market interest rates decline, the yields on existing bonds decline as well, making the chosen answer the correct one.