Final answer:
A bond sells at a discount when its effective interest rate is lower than the stated rate because it offers less attractive returns than what is currently available in the market.
Step-by-step explanation:
This is because the bond becomes less attractive compared to other bonds with higher interest rates. To make the bond appealing to investors, the seller reduces its price below the face value of the bond.
In the given scenario, if the interest rates rise to 12% and there is only one year left until the bond's maturity, the 8% bond would be unattractive to investors. The bond seller would lower its price below the face value to incentivize investors to buy it.
When the effective interest rate of a bond is lower than the stated interest rate, the bond will indeed sell at a discount. This situation occurs because the bond's fixed rate of interest is less attractive to investors compared to the higher interest rates available in the market. For example, if a bond with a stated interest rate of 8% is issued when the market interest rate is 12%, investors can receive a higher return elsewhere.
Consequently, the bond's price will decrease below its face value to reach a point where its effective yield corresponds to the current market rate, compensating for the lower interest payments. Therefore, the statement is true.