Question

Pacific Amalgamated (PA) issues 10-year bonds in 2011 with a $1,000 face value and a $150 coupon. The interest rate at which PA issues these bonds is _____. When the bond reaches maturity in 2021, how much will each investor holding one of these PA bonds receive?

A.)The initial investment of $1,000 plus $150 for the 10th coupon

B.) The initial investment of $1,000 plus $1,500 worth of coupons ($150 per year x 10 years)

C.) $1,500 worth of coupons ($150 per year x 10 years)

Suppose interest rates rise dramatically. The market price of these PA bonds will _____ (increase/decrease/stay the same --select one).

Answer 1

Face value = $1,000

Coupon = $150

Calculate the interest rate -

Interest rate = (Coupon/Face Value) * 100

Interest rate = (150/1000) * 100 = 15%

Thus,

The interest rate at which PA issues these bonds is 15 percent.

When the bond reaches maturity in 2021, each investor holding one of these PA bonds receive the initial investment of $1,000 and 10 coupon payments of $150 each.

Hence, the correct answer is the option (B).

There is inverse relationship between interest rate and the market price of bonds.

When the interest rate rises, market price of bonds decreases and vice-versa.

So,

Suppose interest rate rises dramatically. The market price of these PA bonds will decrease.