| Chapter: | Reading | Topic |
A client owns a $1,000 10-year bond. The coupon rate is 6%. The client acquired the bond three years ago at a discount. What is known about the interest rates three years ago?
BondsA borrowing agreement in which the issuer promises to repay a certain amount of money (ie, par value) to the purchaser after a certain period of time (ie, term), at a certain interest rate. are issued with a coupon rate The interest rate printed on a bond. This rate represents the amount of cash the investor will receive in each payment. (ie, stated rate) that remains constant over a bond's life (Choices A and B). For bonds to be competitively priced with investments providing better returns, its current price adjusts to effectively yield the market rateThe actual rate of interest the issuer pays on a bond based on the issue price. The effective rate is often called the market rate of interest or yield..
This creates an inverse relationship between market interest rates and bond prices. As market rates increase, the bond price decreases and vice versa.
Higher market rates make fixed-rate bonds less attractive to investors who can get better returns from other investments, resulting in the bond's price being quoted at a discount The difference between the par value of a bond and the actual cash received when the market rate is greater than the bond's stated rate. (Choice C).
Things to remember:
Bonds are issued with a stated coupon rate that remains constant over a bond's life. When a bond competes with investments that provide better returns (ie, higher interest rates), its selling price adjusts to effectively yield the market rate. Reducing the selling price to increase the yield results in a bond sold at a discount.
Lecture References :
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