This is pretty straightforward story. The example that follows is much too simple, but it makes the point.
Suppose I bought a 10-year Treasury bond with a coupon yield of 2.38%–the going rate–for $1000 yesterday afternoon. For my $1000 I get interest of $23.80 each year for ten years plus my $1000 back at the end of the term.
Let’s say that the Fed raises short-term interest rates sharply this morning, in a way that makes the yield on the 10-year rise to 3.00%–completely unrealistic, but this is just an illustration.
After this happens, for $1000 I can now get a 10-year Treasury that makes ten payments of $30.00 per year–a total over the next decade of $62 more than on the 2.38% bond–in addition to return of my $1000 at the end.
How much is my original 2.38% -coupon bond now worth? Put another way, how much would someone else now pay me for it? I don’t know exactly …but it’s certainly less than $1000.