Final answer:
Tom's interest income from the bond for the year is $600. Interest rates have an inverse relationship with bond prices; if rates go up, the price of existing bonds typically goes down due to less attractive fixed interest payments. The present value of a bond can be calculated using the current interest rate to discount future cash flows.
Step-by-step explanation:
The student's question pertains to calculating the interest income for Tom, a cash basis taxpayer, from a bond purchase. Tom purchased a bond for $10,000 and paid an additional $100 for accrued interest. In December, he collected $500 in interest from the bond. Tom's interest income for the year would be $600. This is because as a cash basis taxpayer, he reports the interest income when it is received. The $100 accrued interest that Tom paid when purchasing the bond is income to him when the bond pays interest due to the prepayment at the time of purchase.
Now, addressing the SEO keyword concerning a change in interest rates and bond pricing:
If interest rates increase, the price one would be willing to pay for an existing bond typically decreases because the fixed interest payments from the bond become less attractive compared to new bonds that are issued at the higher current rates. For example, if a water company issued a $10,000, ten-year bond at 6% interest and you are looking to buy it one year before maturity when interest rates are now 9%, you would expect to pay less than $10,000 for the bond. The actual amount you'd be willing to pay can be calculated using the present value of future cash flows from the bond discounted at the current interest rate.