Final answer:
Annual interest on $150,000 12% bond is $18,000. Bond prices fall as market interest rates rise, since the present value of future payments decreases.
Step-by-step explanation:
The student's question is about calculating the amount of interest paid on bonds. If $150,000 12% bonds are issued and pay interest annually, the calculation would be $150,000 multiplied by 12%, giving us an interest payment of $18,000 annually.
For the questions regarding bond valuation and changes in the market interest rate, we must use the present value formula to determine the current worth of a bond's future payments. When market interest rates rise, the value of existing bonds typically decreases. This is because new bonds would be issued at higher rates, making existing ones with lower rates less attractive. Therefore:
- For a bond issued at a lower interest rate than the market rate, you will likely pay less than its face value.
- The current value of a bond, given the discount rate (market interest rate), can be calculated by discounting its future payments accordingly.
Example Calculation
For the two-year bond paying 8% annually, issued at $3,000, we discount the future interest payments of $240 and the principal repayment of $3,000 by the discount rate. If interest rates rise to 11%, the present value of these payments will decrease, reflecting the bond's decreased value.