Why do interest rates have inverse relationship with bond prices?

When interest rates rise, bond prices fall. Conversely, when interest rates fall, bond prices rise. This is because when interest rates rise, investors can get a better rate of return elsewhere, so the price of original bonds adjust downward to yield at the current rate.

What is the effective interest rate for a bond?

The effective interest rate method uses the market interest rate at the time that the bond was issued. In our example, the market interest rate on January 1, 2020 was 4% per semiannual period for 10 semiannual periods.

Do interest rates affect the principal of a bond?

When interest rates rise, the market value of bonds falls. If you have a bond with a coupon of 3% and the cash rate increases from 3% to 4%, for example, the coupon rate on the bond will now seem less attractive to investors so they’ll be willing to pay less for it.