Final answer:
Under varying economic conditions, a risk-free bond expected to sell for its face value of $1,000 may sell for less to compete with market interest rates. If market rates rise to 12%, the bond's price would drop below face value, with a maximum expected price of $964 to match alternative investments.
Step-by-step explanation:
When considering the expected selling price of a new issue of bonds under various economic conditions, it is important to assess the level of risk associated with the bond, market interest rates, and the bond's interest rate. In the scenario where the bond pays $80 per year and has a face value of $1,000, if there is no risk, the bond would normally sell at face value.
However, if market interest rates rise to 12% and there is only one year left to maturity, the 8% bond becomes less attractive. To make this bond appealing to investors, the issuer would need to reduce the bond's price below its face value. With a market interest rate of 12%, you would not expect to pay more than $964 for the bond as you could make an alternative investment at the market rate and receive $1,080 in a year's time, which is the expected payment from the bond including the final interest payment and the principal repayment.