Actually, this inverse relationship makes perfect sense. When current interest rates go down, bond buyers will pay more for an existing bond that yields 6% than they will for a new bond that yields only 5%. And on the flip side, if interest rates go up, a buyer will pay less for an old bond that is carrying a lower yield than the bonds that are now being released. Here’s an example of how bond prices reflect the going yields. In June 2003 the yield on a five-year Treasury note with a face value of $1,000 was about 2.5%. But if you went out to buy a bond released several years ago yielding about 5%, you’d have to pay $1,100. Because current rates went down, the price of an older bond with a higher yield went up.
This effect is most pronounced for long-term bonds. When interest rates rise, the price of a 5% bond that won’t mature for twenty years (in other words, a bond that will continue to yield 5% every year for twenty years) will fall more than a 5% bond that will mature in five years. And when interest rates fall, the price of a long-term bond will increase more than the price of a short-term bond.