Final answer:
The Ford Motor Company's bonds were selling at a premium, as indicated by the price of 129.7 which is above face value. The interest rate on the bonds was initially set based on the coupon payment relative to the bond's face value. If market interest rates rise, the value of the bonds will decrease to equate the yield with new market rates.
Step-by-step explanation:
On May 9, 2011, Ford Motor Company's 9.3 percent bonds maturing on March 1, 2030, had a quoted bond price of 129.7. Since the bond price is above 100, this means the bonds were selling at a premium. This is because bond prices are typically quoted as a percentage of the face value (100 being equal to face value). Therefore, any price above 100 indicates a premium, whereas a price below 100 indicates a discount.
a. The interest rate Ford is paying on the borrowed funds can be determined by looking at the annual coupon payment and the face value of the bond. For example, if Ford issues a five year bond with a face value of $5,000 that pays an annual coupon payment of $150, the interest rate is 3% ($150 is 3% of $5,000).
b. If the market interest rate rises from 3% to 4% a year after Ford issues the bonds, the value of the bond will decrease. This is because the bond's fixed coupon payments are now less attractive compared to the new bonds issued at the higher market interest rate. Consequently, the bond's price will drop to increase its yield to match the new market rates.