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All bonds come with a coupon interest rate, which is the fixed annual interest a bond pays. The dollar amount, not the percentage, is fixed over time.

A bond with a $1,000 face value and a 5% coupon rate pays $50 in interest a year, even if its price changes. If the bond’s price climbs from $1,000 to $1,500, its effective yield changes from 5% to 3.33%. If it falls to $750, its yield is 6.67%. Coupon rates are fixed; yields are not.

When market interest rates are higher than the coupon rate, the price of the bond on the open market will drop. Investors don’t want o buy a bond with a 5% yield when one with a 7% yield is available elsewhere. Less demand pushes the bond’s price down until it reaches an equilibrium price of about $715.

If a bond has a 5% coupon and the general interest rate is 3%, investors will buy the bond to receive a bigger return. More demand makes the bond’s price climb to about $1,666.

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