SIE Ready📈 Economic Factors · Lesson 2 of 5 · 5 min
Rates, Bond Prices and the Yield Curve
🎢 Interest rates and bond prices sit on opposite ends of a seesaw. Once you feel that, half the bond questions on the SIE answer themselves.
💡 Key idea
Rates up, prices down. Normal curve slopes up; inverted means short yields exceed long yields.
🧠 Why it matters
Key rates: the FED FUNDS rate (overnight bank-to-bank, targeted by the FOMC), the DISCOUNT rate (Fed loans to banks) and the PRIME rate (what banks charge their most creditworthy business borrowers; it sits well above fed funds). When market rates RISE, existing bond PRICES FALL, and vice versa. A YIELD CURVE plots yields against maturity for similar-quality bonds, usually Treasuries. NORMAL: upward sloping, long rates above short, because lenders want more for tying money up longer. INVERTED: short rates above long, often seen when the Fed is tight and markets expect slowing or a recession. FLAT: little difference, often a transition between the two.
📈 In the real world
Priya Shah holds a 10-year bond paying 4%. New 10-year bonds now pay 5%. Nobody will pay her full price for a 4% bond when 5% is available, so her bond's market price drops until its yield competes. Her rep notes the drop is a price change, not a missed payment: the coupon keeps arriving.
📌 Takeaways
- Bond prices move opposite to interest rates
- Normal yield curve: long-term yields above short-term
- Inverted curve: short-term yields above long-term, often before slowdowns
📖 Terms in this lesson
Federal funds rate: The rate banks charge each other for overnight loans of reserve balances; the FOMC sets a target range for it.
Prime rate: The base rate banks charge their most creditworthy business borrowers, which tends to move with the fed funds rate.
Yield curve: A graph of yields across maturities for similar bonds: normal slopes upward, inverted slopes downward, flat shows similar yields.
Inverted yield curve: A curve on which short-term yields are higher than long-term yields, widely watched as a possible warning of slowing growth.
✅ Test yourself
A yield curve on which 2-year Treasuries yield more than 30-year Treasuries is described as:
- Inverted
- Positive
- Normal
- Flat
Answer: A · Inverted
When short maturities yield more than long maturities, the curve is inverted. A normal (positive) curve slopes upward, and a flat curve shows little difference between maturities.
If market interest rates rise, the price of an existing fixed-rate bond will most likely:
- Fall
- Double
- Rise
- Stay at par
Answer: A · Fall
Existing bonds must offer competitive yields, so their prices fall when rates rise. They do not rise, and a bond trades at par only when its coupon matches market yield.
The rate banks charge their most creditworthy business borrowers is the:
- Coupon rate
- Prime rate
- Discount rate
- Federal funds rate
Answer: B · Prime rate
The prime rate is the bank lending rate for top business customers. The discount rate is what the Fed charges banks, fed funds is the overnight interbank rate, and a coupon is a bond's stated interest.
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