How do bond prices typically react when interest rates go down?

When interest rates decline, bond prices generally increase. This relationship is driven by the fixed nature of bond coupon payments. When new bonds are issued at a lower interest rate, existing bonds with higher coupons become more attractive to investors because they yield a higher return compared to newly issued bonds. As demand for these existing bonds rises, their prices go up in the marketplace.

Moreover, when interest rates decrease, the present value of a bond's future cash flows (the coupon payments and the principal repayment at maturity) increases. This is due to the inverse relationship between interest rates and the present value of cash flows; lower interest rates make future cash flows worth more today, driving up the price of the bond.

In summary, the dynamics of supply and demand, coupled with the present value calculations, lead to an increase in bond prices when interest rates fall. This reflects a fundamental principle in finance regarding the inverse relationship between interest rates and bond prices.