Final answer:
The investment scenario provided touches on the concepts of bond investment, par value, coupon rate, and market price. The yield or total return on a bond includes both interest payments and capital gains, which can fluctuate based on market interest rates. By contrast, the rate of return for stocks, as indicated by S&P 500 historic data, includes dividends and capital gains which have varied across decades.
Step-by-step explanation:
The scenario given discusses the investment in Grath Oil where Sam bought bonds with a par value of $1,000 at a market price of 93.938 and with an annual coupon rate of 6.5%. To address the concepts outlined in the student's question, it's important to understand how bonds work, the yield on a bond, and how market conditions like interest rates affect their value. When Sam invests in bonds, she receives regular interest payments (coupons) based on the stated coupon rate, which remains fixed throughout the life of the bond. Additionally, she may experience capital gains or losses depending on changes in the market interest rates. If interest rates rise, the bond's market price will generally fall, and if interest rates fall, the bond's market price may rise.
In the example information provided, an investor receives an $80 coupon payment on a bond and the bond's face value of $1,000 at maturity. If the bond was purchased for $964, the yield, or total return, can be calculated as (($1,080 - $964) / $964) = 12%, which is a combination of interest payments and capital gains. This highlights that while the coupon rate remains consistent, the bond's yield changes with the purchase price. Comparing this to the S&P 500 index annual return rate, which is a combination of dividends and capital gains, we see that returns from stock investments can vary significantly over time and may involve a different risk-return profile compared to bonds.