Final answer:
With the rise in market interest rates from 6% to 9%, the price of the bond would be expected to fall below its original $10,000 face value. The specific price can be calculated using the present value formula, considering the time remaining until maturity and the new yield required by the market.
Step-by-step explanation:
Understanding Bond Valuation and Interest Rates
When considering the purchase of a 10-year bond with a 6% interest rate from a local water company, we observe a scenario where market interest rates have increased to 9% one year before the bond's maturity. Due to the inverse relationship between bond prices and interest rates, we would expect the price of the bond to be less than its original face value of $10,000. The bond's price must adjust downward so that its yield to maturity matches the current higher market rates.
Calculating the Bond's Value
To calculate the actual price you would be willing to pay for the bond, you need to determine the present value of the bond's future cash flows (the final coupon payment and the repayment of the principal) discounted at the new interest rate of 9%. The formula for present value is:
Present Value = Coupon Payment / (1 + Yield/100)^n + Face Value / (1 + Yield/100)^n
Plugging the appropriate numbers into the formula provides a present value, which would be the most you would want to pay for the bond given the increased market interest rate.