Question

If a coupon bond has a face value of $1,000, I don't understand why anyone who owns the bond would sell it for less than $1,000. After all, if the owner holds the bond to maturity, the owner knows he or she will receive $1,000, so why sell for less? Answer the student's question.

A. If the market interest rate has decreased since purchasing the bond, the price of the bond will have risen relative to what you paid for it and you will realize a capital gain.

B. Bonds are sold at price that is significantly less than the face value of the bond, and then the price rises over time. Thus, you can always sell the bond for more than you paid for it and realize a capital gain.

C. If the market interest rate has increased since purchasing the bond, the price of the bond will have risen relative to what you paid for it and you will realize a capital gain.

D. None of the above.

Answer 1

A. If the market interest rate has decreased since purchasing the bond, the price of the bond will have risen relative to what you paid for it and you will realize a capital gain.

There is an inverse relationship between price and interest rate. When interest rates goes down, price of the bond will increase. If interest rate goes down lower than the coupon rate, the bond can be sold at a price higher than the face value of $1,000. Therefore, in both cases, the investor can realize a capital gain if the market interest rates goes down.