When a given bond's price increases, we know that the interest rate on this bond: Select one: a. remains unchanged. b. must increase. c. must decrease. d. could increase, decrease, or remain unchanged.

c. must decrease.

Explanation:

Bond and interest rates are inversely proportional. This simply means that, when the price of bond rises, the interest rates falls, and when the price of bond falls, the interest rates rises.

For example:

Hypothetically, you bought a bond at a price of $100 with an annual fixed interest rates of 4% for 4years which will be $4 per year. After a year, the same amount of bonds in the market, has a 5% annual increase. However, you don't want to wait till maturity, and you intend to sell your bond.

Your bond compared to other bonds in the market goes thus:

Your bond at $100 with interest rates of $4 per year for the next three years will equal to $12 of interest at maturity stage.

While others bonds of the same price with $5 interest rate annually will equal $15 of interest at maturity stage.

Therefore, no reasonable buyer will buy your bond at such interest rates. So to find a buyer, your bond price will have to be reduced to $97 at $4 annual interest rates.

Therefore, for the buyer, he will make ($4 x 3) which is for three years interest and it will be equal to $12, then plus additional $3 when the bond matures, which now equals $15, will then equates to the same amount of interest yield compared to other bonds of $100 at 5% annual interest rate for 3 years.

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