If interest rates decline, which type of bonds will likely increase the most in market value?

When interest rates decline, long-term bonds are likely to increase the most in market value due to their sensitivity to interest rate changes. The relationship between bond prices and interest rates is inverse; as rates drop, the fixed interest payments of existing bonds become more attractive compared to new bonds issued at the lower rates.

Long-term bonds have a longer duration, meaning they have cash flows that are received further into the future. This makes their present value more sensitive to changes in interest rates. The longer the maturity of a bond, the greater the impact that a change in interest rates will have on its price. Therefore, when rates fall, the price of long-term bonds rises more significantly as investors are willing to pay a premium for those higher fixed interest payments compared to new lower-yielding bonds.

In contrast, short-term and intermediate-term bonds experience less price appreciation because they mature sooner and therefore their cash flows are less affected by changes in prevailing interest rates. While all bonds may benefit from a decline in interest rates, the magnitude of the increase in market value is typically greatest for long-term bonds.