Final answer:
The interest rate in the bond indenture is called the coupon rate, not the effective yield or market rate, making the statement false. The effective yield or market rate varies with market conditions and represents the actual return on a bond based on its current market price.
"The correct option is approximately option 2"
Step-by-step explanation:
The statement that the interest rate written in the terms of the bond indenture is called the effective yield or market rate is false. The rate written in the bond indenture is actually known as the coupon rate, which is the fixed interest rate the issuer agrees to pay bondholders, based on the bond's face value. The effective yield, also called the market rate, refers to the rate of return on a bond based on the market price, which fluctuates due to changes in the market interest rates. Investors are concerned with effective yield as it reflects the actual return they earn on a bond if they were to buy it on the market.
For example, consider a bond with a face value of $1,000 and a coupon rate of 5%. If market interest rates rise to 6%, the bond's price would typically fall because its fixed payments are less attractive compared to newer bonds issued at the higher current rate. Consequently, a new investor could buy the bond at a discount to achieve a yield to maturity that's equivalent to the new market rate of 6%.
Bond valuation and yield dynamics form a critical aspect of investment strategies, as they indicate potential gains or losses due to interest rate fluctuations. Therefore, it's essential for investors to understand the difference between the coupon rate and the effective yield to assess the true value of a bond investment accurately.