Final answer:
A bond with a 2.85% yield that pays a $25 coupon will likely be priced at a premium, meaning above its face value, because the yield is lower than what is typically expected for such a coupon. If prevailing market interest rates are higher, the bond's price would decrease to compete with new bonds offering higher yields.
Step-by-step explanation:
When a financial planner recommends a bond that pays a $25 coupon and has a 2.85% yield, a few things are implied about the bond's price. In the context of bond pricing, yield refers to the return an investor will receive by holding the bond to maturity. If the yield is less than the bond's coupon rate, the bond is selling at a premium, meaning the price of the bond is higher than its face value.
Consider a zero-risk bond that is supposed to pay an annual interest and is sold at its face value ($1,000), such as one that pays $80 per year in interest. If prevailing interest rates in the market rise well above the bond's coupon rate, the bond's value would decrease as it becomes less attractive to investors, given the new yield that new bonds in the market may offer. For example, if market rates rise to 12%, the previously issued bond with an 8% coupon would likely sell for less than $1,000 to remain competitive. Similarly, evaluating the current bond under discussion, the price can be assumed to be above its face value (a premium) since the yield is substantially lower than the coupon rate if we assume a standard coupon rate of higher than 2.85%.