A person holds bonds. The market rate of interest rises. What happens to her wealth held in bonds?
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → She suffers a capital loss, as the price of her bonds falls.
Bond prices move opposite to the market rate of interest. When the rate rises, her bonds are worth less. This fall in her wealth is a capital loss.
Option (1) She suffers a capital loss, as the price of her bonds falls. — Correct. A higher rate lowers the bond price.
Option (2) She makes a capital gain, as the price of her bonds rises. — Incorrect. Bond prices rise when the rate falls.
Option (3) She suffers no loss, as her bonds still pay the same fixed return every year. — Incorrect. The return is the same, but the price falls, so her wealth falls.
Option (4) She makes a capital gain, as her bonds now earn the higher rate of interest. — Incorrect. Her bonds keep their fixed return; only their price changes.
NCERT (2026-27): “The Speculative Motive … Now consider an increase in the market rate of interest from 5 per cent to 6 per cent. The present value, and hence the price of the same bond, will become … 107.33 (approx.) |