Final answer:
The $1,000 that Dilan will receive at maturity is referred to as the bond's principal. Bonds come with interest rate risk, meaning their value can fluctuate with market interest rates. Calculations such as present discounted value are used to determine what future payments are worth in today's dollars, adjusting for changes in interest rates.
Step-by-step explanation:
Dilan owns a bond that will pay him $45 each year in interest plus $1,000 as a principal payment at maturity. The $1,000 is referred to as the principal of the bond. This is the amount that was originally loaned and will be repaid to the bondholder at maturity, separate from the interest payments which are referred to as coupons. Bonds carry an interest rate risk, which means the value of these financial securities can be affected by changes in interest rates. For instance, if you buy a bond with an 8% interest rate and then rates increase to 12%, new bonds pay more, making your old bond less attractive and hence it may trade at a discount in the secondary market.
Given the interest rate risks associated with bonds, it is important to understand concepts like present discounted value—the amount of money you would need today to equate to a future sum, given a certain interest rate or discount rate. The actual calculation of present value requires you to discount future cash flows back to the present time, providing a tool to assess the worth of future payments.
For example, a simple two-year bond with a face value of $3,000 and an 8% interest rate would pay $240 in interest each year and return the principal at the end of the second year. If the discount rate is the same as the interest rate (8%), the present value would be equal to the bond's face value. If the discount rate rises to 11% due to an increase in market interest rates, the present value of the bond would decrease accordingly, calculated using the present value formula which accounts for the time value of money.