Question

A bond has the following terms: 1) a $1,000 par value; 2) annual interest payments of $100; 3) coupon rate of 10%; 4) 5 years to maturity; 5) cannot be called, and 6) is not expected to default. (T/F) The bond should sell at a premium if interest rates are below 10% and at a discount if interest rates are greater than 10%. True or False?

Answer 1

Answer:

True

Explanation:

Bonds coupon rate = 10%

If market interest rates are below 10%, then investors will bid up the price to buy it since it pays better interest than the market rate. This bid up will result in higher price until yield to maturity on the bond is in line with market rate of interest. Hence bond will sell at premium.

If market rate of interest rates are greater than 10%, investor will not be interested in buying the bond unless it is sold at a discount, since market rate provides better investment alternatives.

Hence the statement is TRUE.