Interest rate changes have a direct and powerful impact on a bond’s yield to maturity (YTM). When market interest rates rise, existing bond prices usually fall, causing their YTM to increase. This happens because new bonds are issued with higher coupon rates, making older bonds with lower returns less attractive. To compete in the market, the price of the existing bond must decrease until its yield aligns with current rates.

Conversely, when interest rates decline, bond prices rise and YTM falls. Investors are willing to pay more for existing bonds that offer higher coupon payments compared to new issues with lower rates. This inverse relationship between bond prices and yields is a fundamental principle of fixed-income investing.

The sensitivity of a bond’s price to interest rate changes depends on its duration and time to maturity. Long-term bonds typically experience larger price swings than short-term ones when rates move. For this reason, investors often monitor interest rate trends closely to manage risk and optimise returns.

Understanding how interest rate fluctuations affect YTM helps investors make informed decisions about when to buy or sell bonds. It also aids in portfolio diversification and interest rate risk management, ensuring that potential losses from price changes are balanced with the investor’s income and growth objectives.