Final answer:
The price Pete paid, $1,032, for the bond is referred to as the dirty price, which includes the face value and accrued interest. Therefore, the correct option is 4).
Step-by-step explanation:
The total cost that Pete paid for purchasing a bond, which is $1,032, is known as the dirty price. This price includes not only the bond's face value (or clean price), but also accrued interest since the last coupon date. The clean price is the price excluding accrued interest. The dirty price is relevant to the actual transaction, as it is what the buyer pays to acquire the bond. In a scenario where a bond carries no risk, it would be issued at its face value, perhaps $1,000, and provide periodic interest payments (coupons) until its maturity.
However, if market interest rates rise above the bond's coupon rate, the bond becomes less attractive to investors. To compensate, the bond's price will drop below its face value to offer a competitive yield. For example, if the market rate is 12%, and a bond with a face value of $1,000 pays 8%, the bond's price will have to be adjusted downward to attract buyers. Consider a bond expected to pay $1,080 in one year—$1,000 in face value plus $80 in interest. At a market rate of 12%, this payment is equivalent to an investment of $964 today ($964 multiplied by 1.12 equals $1,080). This indicates the bond's price in the market should not exceed $964, which is substantially less than the face value of $1,000. Therefore, the quoted price, spread price, call price, and clean price are incorrect in the context of the total amount Pete paid. As such, the correct option is dirty price.