Final answer:
When interest rates rise, the price of existing bonds typically decreases to yield a market-equivalent rate. Therefore, for the mentioned bonds, you would expect to pay less than the face value if the bond interest rates are below the new market rate. Present value calculations are used to adjust the price of bonds in response to changing interest rates.
Step-by-step explanation:
A $10,000 face value bond costs $9,250 and matures in one year. If the interest rate on similar bonds rises by 2%, you would generally expect the price of the bond to decrease. This is because the bond's fixed interest payments become less attractive compared to the new bonds issued at the higher rate, causing the existing bond's price to adjust downward to offer a similar yield to the market.
Considering a local water company issued a $10,000 ten-year bond at an interest rate of 6%, and you are thinking about buying this bond one year before the end of the ten years, but interest rates are now 9%. Given the change in interest rates, you would expect to pay less than $10,000 for this bond because the market rate is higher than the bond's coupon rate.
For a simple two-year bond issued for $3,000 at an 8% interest rate, the bond will pay $240 in interest each year. To find out how much this bond is worth now, you would discount these future cash flows back to the present at the prevailing discount rate. If the discount rate is 8%, then the present value of the bond might be equal to its face value. However, if interest rates rise and the new discount rate is 11%, the present value of the bond would decrease, and it would be worth less.