Which of the following statements is NOT CORRECT? a. When a bond's coupon interest rate is...

Which of the following statements is NOT CORRECT?

a. When a bond's coupon interest rate is less than the market interest rate, the bond will sell at a value less than its par value and is known as a discount bond.

b. Bonds are basically loans, so they usually make regular interest payments to the bondholders. The percentage of this interest payment relative to the bond's face value is called the coupon interest rate.

c. For a fixed-rate bond, the coupon interest rate is set for the life of the bond. Unlike a fixed-rate bond's coupon interest rate, the market interest rate changes throughout the life of the bond and has a huge impact on the bond's price.

d. When the market interest rate is higher than the coupon interest rate, the bond price rises above the par value and is called a premium bond.

e. When a bond's coupon rate is equal to the market interest rate, the bond will sell for its face value, or what is known as selling at par.

Expert Solution

When market interest rate (say 10%) is greater than the coupon interest rate of the bond (say 8%), the bond price will drop as investors would otherwise invest in the higher yielding assets. With bond price declining below par value (known as discount bond), the effective interest rate earned by an investor will be higher than the coupon rate (of 8%). Hence, option A is the correct answer.

On the other hand, if market interest rate is less than coupon interest rate, bond prices will increase and trade at a premium to par value (known as premium bond). If coupon rate = market rate, the bond will trade at par value.

c) Bond price is inversely related to interest rates, and as rates change, so do bond prices.

jeff jeffy answered 2 years ago

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