Final answer:
A bond issued at a premium means the stated rate of interest exceeded the market rate at the time of issuance. Market interest rate increases make existing bonds with lower rates less attractive, often causing their market price to fall below face value.
Step-by-step explanation:
If Stone, Inc. issued bonds at a premium, this indicates that the stated rate of interest exceeded the market rate of interest at the time of issuance. Bonds are issued at a premium when investors are willing to pay more than the maturity amount for the bonds because the interest payments they will receive over the life of the bond are higher compared to the current market rates. The bond's premium compensates investors for the lower yield they would otherwise obtain from the market.
To apply this concept to a specific example, consider a bond carrying no risk that sells for $1,000 at issuance, paying $80 per year until maturity. If market interest rates later rise to 12%, new bonds would likely offer a higher interest rate, making existing bonds with lower rates less attractive. To sell an existing 8% bond in this market, the bond's price would be reduced below its face value to make it a competitive investment.
In relation to the provided scenarios:
a. Given the rise to a 9% interest rate, you would expect to pay less than $10,000 for the local water company's 6% bond one year before its maturity.