Final answer:
The question involves understanding how bond prices are impacted by changes in market interest rates, and how investors determine the price they are willing to pay for bonds with different coupons and maturities under various interest rate scenarios.
Step-by-step explanation:
The subject of the student's question pertains to the pricing and interest rate risk associated with bonds. Specifically, it refers to the scenario of a company, Uliana Company, looking to issue new 20-year bonds and how market factors can affect bond prices.
The discussion includes how bond prices adjust when the prevailing interest rates in the economy increase and how that affects investor decisions to purchase bonds. In the face of rising interest rates, older bonds with lower interest rates, such as the bond with an 8% coupon in the hypothetical scenario, may be sold at a discount to attract investors.
To illustrate this, we consider the case of buying a bond issued at 6% one year before maturity, when the market interest rate has risen to 9%. The investor would expect to pay less than the face value for this bond due to the change in interest rates, as the bond's fixed interest payments are now less attractive compared to new bonds issued at the higher current rates.
Calculating the Purchase Price of the Bond
Assuming the bond's face value is $10,000 with one year remaining and a 6% coupon rate while the market rate is 9%, the bond's price can be calculated as:
- Current year's coupon payment: 6% of $10,000 = $600
- Discounted value of the coupon and face value repayment: ($600 + $10,000) / (1 + 9%)
Thus, the investment's present value and the price an investor would be willing to pay for the bond would be less than $10,000 due to the high market interest rates.