You have bought a 10-year bond with a 10% yield. The next day interest rates move to 15%. You will still receive £10k per year. But the value of your bond has dropped significantly.
£100k would now buy you £15k per year with £100k payment at the end.
You clearly do not need as much as £100k to generate £10k a year with 15% interest rates.
In fact, to buy this same stream of “£10k per year and £100k at the end” would only cost you £75k.
For the more mathematically minded, you simply calculate the Present Value (PV) of all the cashflows using 15% as the discount rate. (bond maths is really not very hard).
Context – You were holding the funds for your gang as the proceeds for a drug deal being completed later today. When you turn up with only £75k rather than £100k your associates are going to kill you. Painfully.
If you had been lucky and rates had fallen to 5% instead, then you would have handed over the £100k and kept a tidy profit of £39k for yourself. Was it worth the risk?
You really should have managed your risk better.
Would you like to change your vote to answer B? if so click here.