Question

A bond with a $100 annual interest payment with five years to maturity (not expected to default) would sell for a premium if interest rates were below 9% and would sell for a discount if interest rates were greater than 11%.

Answer 1

Par value of bond = $1,000

Annual Interest rate = $100

Coupon rate = $100 / $1,000

= 10%

Coupon rate of bond is 10%.

The relationship between price of bond and market interest rate is inverse. That is when interest rate rise, price of bond decreases and when interest rate falls bond price increase.

So, if interest rates were below 9% then Price of bond must be increase from Par value of $1,000 and in this case bond is trading at premium.

Again, if interest rates were greater than 11% then price of bond fall below Par value, and in this case bond is trading at discount.