Final answer:
The price of bonds on the secondary market moves inversely to changes in interest rates; when rates fall, bond prices rise and when rates rise, bond prices fall.
Step-by-step explanation:
When the interest rates change in the financial markets, the price of bonds in the secondary market is affected inversely. If interest rates decrease, the value of a bond that was issued at a higher interest rate will increase.
This is because the fixed interest payments of the bond are more attractive compared to the new lower rates available, leading investors to pay a premium for it.
Conversely, if interest rates increase, the value of the existing bond will decrease as its fixed interest payments become less appealing than new bonds issued at the higher rates.
Therefore, a bond will sell for less than its face value. Ultimately the present value of the bond's cash flows, which involves discounting the future payments by the current interest rate, determines the bond's market price. The had effect is that a bond's price moves in the opposite direction of interest rate changes.