Arbitrage in bonds a bond pays a fixed stream of payments of Sx per year, no matter the interest rate paid by banks At an initial equilibrium the rate-of-return to holding a bond must be R=r,,the initial bank interest rate If the bank interest rate rises to r>r then r>r and the bond should be sold Sales of bonds lower their market pricesArbitrage in Bonds A bond pays a fixed stream of payments of $x per year, no matter the interest rate paid by banks. At an initial equilibrium the rate-of-return to holding a bond must be R = r’, the initial bank interest rate. If the bank interest rate rises to r” > r’ then r” > R and the bond should be sold. Sales of bonds lower their market prices