Question

The value of a bond declines when market interest rates rise, because _____ a. the coupon...

The value of a bond declines when market interest rates rise, because

_____ a. the coupon rate of the bond declines and the bond pays less interest

_____ b. the coupon rate of the bond is fixed and the effective interest rate must equal the market

_____ c. the company’s performance has improved, making the bond less risky.

_____d. the amount of interest the bond pays increases, lowering the required rate of return.

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Answer #1

Option 'b' is correct

The coupon rate of the bond is fixed and the effective interest rate must equal the market.

Coupon rate is fixed and not changes with change in market interest rate. If the market interest rate rises the price of the bond declines because investor would get more amount if he invests in the market instead of investing in the bond. The demand of the bond decreases so the value of the bond decreases.

The effective interest rate will equal the market rate. So, new investor would find no difference in purchasing the bond rather than investing in the market.

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