Final answer:
Rory may not deduct the interest he pays on a loan used to purchase tax-exempt Oklahoma state bonds. Interest rates have an inverse relationship with bond prices, so if interest rates rise, existing bonds with lower rates lose value. In a scenario where interest rates have gone from 6% to 9%, one would expect to pay less for an existing bond due to this inverse relationship.
Step-by-step explanation:
False - Rory may not deduct the interest he pays on a loan used to purchase Oklahoma state bonds. Typically, personal interest expense, including that on loans to purchase tax-exempt securities such as state bonds, is not deductible under the Internal Revenue Code U.S. tax law. Only specific types of interest, such as mortgage interest and student loan interest, qualify for a deduction under certain circumstances.
Understanding Bond Purchases and Interest Rates
Regarding the valuation of bonds, when interest rates increase, the market value of existing bonds with lower interest rates tends to decrease. This is because new bonds would likely be issued at the new, higher rates, making them more attractive to investors than the old bonds with lower rates. Conversely, if interest rates decrease, existing bonds with higher rates become more valuable than new bonds at the current lower rates.
Thus, if a local water company issued a $10,000 ten-year bond with a 6% interest rate and you are considering buying this bond one year before maturity, but interest rates have risen to 9%, then you would expect to pay less than $10,000 for the bond on the open market, as investors would favor new bonds with the higher interest rate over your bond with the lower rate.