Bonds. Interest rate risk
When interest rates go up, prices fall.
And when interest rates go down, prices increase.
It's easiest to explain this with an example!
Assume the government issues two bonds, both with annual interest payments and a maturity of 3 years. First the government issues a 4% bond and then immediately afterwards, issues a 5% bond.
If you could buy either bond for £100, which would you buy?
You'd buy the 5% bond.
Intuitively, you know that you wouldn't pay £100 for the 4% bond!
But you might pay something less than £100 if it gave you the same 5% return.
The only negotiable feature of a bond is the price. Given that we know that the two bonds are identical, except for the coupon, the only way to make them equal investments is for the price of the 4% bond to fall until it reaches a price that gives you a 5% return.
In this example, you would be willing to pay about £97.28 for the 4% bond because this would make the return about 5%. You would receive 4% of interest per £100 face value bond and you would receive £100 back at maturity.
For personal tax reasons, some investors might actually prefer the 4% bond in this example because some of the return would come from a capital gain of about £5 when the bond matures.