Which of the following is certainly true regarding interest rates?

Which of the following is certainly true regarding interest rates?

a. Increases in interest rates lead to increases in stock prices,

b. Increases in interest rates lead to increases in bond prices,

c. Increases in interest rates lead to decreases in bond prices,

d. The effect of a change in interest rates on bond and stock prices is unknown,

e. Interest rates do not affect stock or bond prices.

Answer: c. Increases in interest rates lead to decreases in bond prices,

Fluctuations in interest rates also impact on the return on an investment in that when interest rates are high, the prices of existing bonds drop. This is due to the fact that, as newly issued bonds are brought to the market, they will carry higher yields due to the increased interest rate levels to warrant presentation to the investors, thus resulting in lesser appeal to the existing bonds yielding lower rates. Thus, the yields of existing bonds have to rise, while their rates have to decrease in order to better compete in the market. On the other, with the decline in the interest rate, the prices of existing bonds goes up because that will offer higher yield than what the new bonds are offering in the market. This is a very basic concept in fixed interest securities whereby the higher the interest rates, the lower the prices of bonds and vice versa.