Final answer:
The effective interest rate on the Chang Corporation's bonds is b. above 9% due to the bonds being issued at a discount. In a rising interest rate market, existing bonds with lower coupon rates will sell for less than face value to offer a competitive yield. Bond pricing is inversely related to market interest rate fluctuations.
Step-by-step explanation:
The effective interest rate on the bonds issued by Chang Corporation can be determined by considering the issue price and the stated interest rate. Chang Corporation issued the bonds at 96.1, which means at a discount. Investors who bought these bonds at a discount would have received 9% interest based on the face value of the bonds, but since they actually paid less for each bond, their effective yield or interest rate would indeed be higher than the stated 9%.
Now, let's consider the hypothetical case included in the question to illustrate how market values change with interest rates. Imagine a local water company issued a $10,000 ten-year bond at an interest rate of 6%. If you are thinking about buying this bond one year before the end of the ten years but the market interest rates have risen to 9%, you would expect to pay less than $10,000 for the bond since investors will seek a bond that offers them a competitive interest rate. Specifically, the investor will want the yield to maturity to at least match the current market rate of 9%.
Using the provided example, if the bond has a face value of $1,000 and one year of interest left which amounts to $80, and the bond is currently priced at $964, then the yield on the bond would be ($1080 - $964)/$964 = 12%, which is the total yield assuming the bond is held until maturity. This demonstrates how bonds sell for less than their face value when market interest rates rise above the bond's coupon rate.