Final answer:
When market interest rates rise, the price of fixed-rate bonds falls. For a bond with a 6% coupon, if market rates are at 9%, the bond will be worth less than its face value. For the $10,000 bond at 6% when rates are 9%, you'd be willing to pay roughly $9,724.77.
Step-by-step explanation:
If a local water company issued a $10,000 ten-year bond at an interest rate of 6%, and you consider buying it a year before maturity when market interest rates have risen to 9%, you would expect to pay less than $10,000 for the bond. This is due to the inverse relationship between bond prices and market interest rates - when market interest rates rise, existing bonds with lower coupon rates become less attractive, hence their prices decrease to compensate investors for the lower rate.
For calculating the price you would be willing to pay for the bond, you should compare the bond's fixed coupon payments and the maturity value to the current market rates. Since the bond will pay $600 (6% of $10,000) and repay the principal after a year, and you could earn 9% in the current market, you can calculate the present value of these cash flows discounted at the market rate of 9%. The calculation would look like this:
- Present Value of coupon payment = $600 / (1 + 0.09) = $550.46
- Present Value of principal = $10,000 / (1 + 0.09) = $9,174.31
- Total Present Value = $550.46 + $9,174.31 = $9,724.77
So, you would be willing to pay approximately $9,724.77 for the bond in this market condition.
Moving on to Ford Motor Company's bond, if it pays an annual coupon payment of $150 on a face value of $5,000, the interest rate it is paying is 3% ($150/$5000). If the market interest rate increases from 3% to 4% a year after issuing the bond, the value of the bond will decrease, again due to the inverse relationship between bond prices and market interest rates.