An investor purchases a 20-year corporate bond with a 5% coupon rate at its par value of $1,000. Two years later, market interest rates for comparable debt securities rise to 7%. Which of the following statements best describes the impact of this interest rate increase on the bond's secondary market price and nominal yield?
- The bond's market price will drop below par value (sell at a discount), while its nominal yield remains unchanged at 5%.Cevap
- BThe bond's market price will rise above par value (sell at a premium) because older bonds offer superior income safety.
- CThe bond's market price will remain unaffected at $1,000 because its stated annual coupon payment is a fixed contractual obligation.
- DThe bond's nominal yield will automatically adjust upward to 7% to match prevailing secondary market interest rates.
Cevap
The bond's market price will drop below par value (sell at a discount), while its nominal yield remains unchanged at 5%.
Bond prices and market interest rates have an inverse relationship. When market rates rise to 7%, an existing bond paying a 5% coupon rate becomes less attractive to investors. To attract buyers, its market price must decline below par value ($1,000), making it sell at a discount. The bond's nominal yield remains constant at 5% because the coupon payment and par value are fixed contractual terms defined at issuance.
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Inverse Relationship Between Bond Prices and Prevailing Interest Rates