Question

A bond has a $1,000 par value, makes annual coupon rate of 10%, has 5 years to maturity, cannot be called, and is not expected to default. The bond should sell at a premium if market interest rates are below 10% and at a discount if interest rates are greater than 10%.

T/F

Answer 1

Bond price and market interest rate are inversely proportional to each other. When interest rate falls, bond price rises and vice-versa. Periodic coupon payments are constant for the entire life of fixed-rate bonds irrespective of the market rate.

When stated rate of a bond is higher than prevailing rate, the bond trades at premium. Bond sells at a price higher than its face value with a premium amount. Investors are willing to peruse this type of bond in order to get higher interest rate than current market rate.

When stated rate of a bond is lower than prevailing rate, the value of the bond declines and hence trades at discount i.e. bonds sell at a lower amount than the face value.

Hence the bond with coupon rate of 10 %, should sell at premium if market interest rates are below 10 % and sell at discount if interest rates are greater than 10 %.

The statement is true.