Let's explore the relationship between bond price and yield while excluding reinvestment returns.

For simplicity, for fixed coupon bonds, the coupon rate is set at the time of issuance, and it remains unchanged throughout a bond's life.

However, as the bond trades in the secondary market, its price can fluctuate, and this price fluctuation becomes really important.

A bond's yield reflects two things, firstly, the coupon payments, and secondly, the gains or losses earned between the purchase price and the par value at maturity.

That price fluctuation now comes in because of this, any change in the bonds price will cause a gain or loss, and thus it will alter the yield to maturity.

This price change affects anyone buying the bond at the new market price.

Based on this, we cander a simple rule about the relationship between bond prices and yields.

When the price of a bond rises, its yield falls and vice versa.

But why does this happen? Well, let's consider an investor who buys a 10 year bond with a 4% fixed coupon at a price of 92% of its face value.

Ooh. In this case, the investor will not only receive the 4% coupon annually, but will also realize a capital gain by buying the bond at the low 92%, and later on receiving 100% at maturity.

This capital gain of eight causes the bond's yield to be higher than the coupon rates, so the lower the bonds purchase price, the larger the capital gain will be, and thus the higher the yield.

Conversely, if the bond's price increases, their capital gain will be reduced, resulting in a lower yield.

This dynamic is the foundation of the well-known inverse relationship between bond prices and yields.

As yields fall bond prices rise and conversely as yields rise, bond prices fall.