When interest rates are rising, why is it not unusual to see falling prices of both bonds and stocks?

Question

When interest rates are rising, why is it not unusual to see falling prices of both bonds and stocks?

Answer 1

When interest rates fall from 15% to  10% say, a newly issued bond of $100 wil earn less than the 10% interest coupon rate$100 bond already in the market. So, a person willing to sell the earlier bond can sell the ol bond he has to a person now willing to buy a bond at more than $100. By this transaction at say $105, the seller makes aprofit or capital gain of $5 while the buyer byus that old bond at $105 but will get an interest of $15 which means an effective yield of 9.5%. So both gains. With competition to buy bonds the old bonds will have to bought by new purchasers at an effective interest yield of 9%. So when interest rates fall, bond prices (old one already traderd in the market see their prices rise.

Similarly when interest rates rise, the bond prices will fall. Because the newly isuued bonds will give higher interest rates, the buyers of old bonds will buy old bonds only if the price of the bond is lower to compensate for the lower interest yield on the old bonds. If the interest of the old $100 bond was 15% and new interest rate is 10%, the old bond will now be purchased at less than $100 so that the interest yield is 20%.

When interest rates rise, the cost of borrwing for the firms rises and hence their profits are adversely impacted. All other things remaining the same the earnings of the shareholders EPS or earning per share will fall and hence the shares will now give lower returns. But the returns have to rise as people would desert shares and go to bonds which give higher interest yield than before. This means stock prices now must fall so that the earning per $ invested in the share or profit made by the comapany per dollar invested in a share rises. Moreover, a rising interest rate may be seen as a contractionary fiscal and monetary policy which means adverse outlook for company's profits in future. So the stock prices fall. This is the rationale for the usuall phenomenon of bond and stock prices falling when interest rates rise.

Answer 2

Well, it's obvious to see why bonds would fall.  Bonds are a fixed-income asset.  So, as interest rise, bonds become less attractive and their present values fall.  Bond prices and interest rates are inversely related.  

Stock prices could fall because people are taking their money out of the stock market and putting it into the bank, thus lowering demand.  The opportunity cost of investing in the stock market will now be a higher interest rate which will lure away investors.

...Ceteris Paribus...