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Markets - Money marketsTheory 4 - Interest rates and security prices - as one goes up the other goes down?A gilt-edged security is a type of fixed-interest security. This means that it always pays a fixed rate of interest - the rate it was issued at. However, other interest rates don't stay fixed, so gilt-edged securities will become more or less attractive depending which way interest rates move. If you have a gilt that was issued at 10%, but market rates of interest have since fallen to 6%, then the gilt-edged security makes an attractive investment. This will make the gilt in heavy demand and when the demand for something increases, what happens to the price? It increases as well. So when interest rates fall, the price of gilts will tend to rise. If we look at a numerical example we can see why this happens. Say a £1,000 security is issued with a £100 annual fixed return. This is an interest rate of 10%. Whoever holds the security will get a return each year of £100. As long as the interest rate stays the same, then the price of the security will stay the same, as the £100 return is exactly equivalent to the market rate of interest. However, say the market rate of interest goes up dramatically to 20% (unlikely in practice, but it makes our numbers easier!). The security is now a pretty unattractive investment as it is only paying an effective rate of 10% at its current price. So, the price will fall. It will keep on falling until the fixed £100 return is 20% of the price. That way it is equivalent to the new market rate of interest. The new price of the security will therefore be £500. The £100 fixed return is then 20% of the value of the security, and it is once again an attractive investment. As we can see prices of fixed-interest securities will therefore vary inversely with the rate of interest. 
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