Final answer:
If the interest rate is 5 percent, people will likely buy bonds, increasing their price, and as a consequence, the interest rate will fall.
Step-by-step explanation:
If the interest rate is 5 percent, people will typically react in a way that aligns with the relationship between bond prices and interest rates. In Financial Markets, if the interest rate falls after a bond is issued, then that bond will sell for more than its face value, because the bond has locked in a higher interest rate than what is currently available. This scenario leads people to buy bonds, bid up their price, and as a result, the interest rate will fall because an increase in bond prices leads to a decrease in their yields which is another way of saying interest rates. Conversely, if the interest rate rises, existing bonds with lower interest rates become less attractive, and they will sell for less than their face value. This is because there is more available loanable funds and lenders are in competition to lend, which drives down the interest rate. Given these dynamics, the correct answer to the student's question is A. buy bonds, bid up their price, and the interest rate will fall.