Final answer:
Bond prices inversely correlate with market interest rates. A bond's price must be reduced to be attractive as a purchase when market rates surpass the bond's issued interest rate. For the given examples, adjustments in price below face value are expected to align with current higher rates before an investor will consider the bond desirable.
Step-by-step explanation:
Understanding Bond Valuation in Relation to Interest Rate Changes
When a bond is issued with a specific coupon rate or interest rate, its attractiveness to investors is relative to the prevailing market interest rates. If a bond with an 8% interest rate is issued when the market interest rate is at 8%, it would likely sell for its face value. However, if market interest rates rise, say to 12%, then that same bond becomes less attractive, as investors can get a better return elsewhere. To make such a bond appealing, the bond's price must be reduced below its face value.
Applying this concept to the student's scenario, where the bond is 13% and matures on October 31, 2032, and the call option is unlikely to be exercised, we can assume the bond operates akin to a zero-risk bond. However, because market rates can change, if they rise above the bond's 13% coupon rate, similar price adjustments would need to occur to maintain its saleability in the market.
For the local water company bond example, given that interest rates have risen to 9% and only one year is left until the bond's maturity, it would be expected to pay less than $10,000 for the bond. The present value calculation would be necessary to determine the exact price one would be willing to pay for it under these market conditions.