Final answer:
To determine the interest payment and price of bonds, one must consider market interest rates. If a bond's rate is below the market rate, its price will be lower than par value. The present value of a bond's future payments decreases when the discount rate increases.
Step-by-step explanation:
Problem 7-2 interest payments (lg7-1) involves determining the interest payment for bonds with a $1,000 par value. For this problem, understanding how bond prices are affected when the bond's interest rate is less than the market interest rate is essential. If the bond's expected payments one year from now are $1,080 and market interest rates are 12%, the maximum price a rational investor should pay for the bond is $964, as this would yield the same return as an alternative investment.
In the scenario where a water company issued a $10,000 ten-year bond at an interest rate of 6%, and current market rates are 9%, one would expect to pay less than the $10,000 par value due to the interest rate increase. As for the present value of a simple two-year bond with an 8% interest rate, if the discount rate is also 8%, the bond's present value would equal the sum of the present value of future payments. If the discount rate rises to 11%, the present value of those future payments would be discounted more steeply, reducing the bond's present value.