A point is one-time charge equal to one percent of the principal amount borrowed. The correct answer to the student's homework question is (c) one percent. When interest rates increase, the price of previously issued bonds typically decreases.
A point is a one-time charge equal to one percent of the principal amount borrowed. Therefore, the correct answer is (c) one percent.
Calculating Bond Price with Changed Interest Rates
When considering the purchase of a bond from a local water company that has an original interest rate of 6%, but market interest rates have risen to 9%, you would expect to pay less than $10,000 for this $10,000 ten-year bond due to the change in interest rates.
Interest Rate Influence on Bonds
Generally, when interest rates in the market increase after a bond has been issued, the price of the bond falls, because new bonds are likely to be issued at the higher current interest rate, making the old bonds less attractive unless they can be bought at a discount. Conversely, if market interest rates fall, existing bonds with higher interest rates become more valuable, and their prices increase.
To calculate the price you would be willing to pay for the bond, you would use the formula:
Interest = Principal × rate × time
If you want to earn a market rate of 9% in the last year, you would calculate the interest that $10,000 would earn at 9% for one year, then discount the bond's future value by that interest amount to find out how much you should pay for it today.