Final answer:
The yield of a $1,000 face value bond with an 8% coupon rate, bought at $964, is 12%, reflecting the adjustment in the bond's price due to changes in market interest rates that affect both interest payments and capital gains.
Step-by-step explanation:
When investors buy a bond, such as a 10-year $1,000 face value bond with an 8% annual coupon rate, they are usually interested in knowing the yield they will receive. The yield is the total return on investment, which includes interest payments and capital gains. If you buy the bond at $964 and it matures at $1,000 with one last interest payment of $80, then the yield is calculated as (($1,080 - $964)/$964) * 100, which equals 12%. This demonstrates that even though the coupon rate remains at 8%, the market conditions, such as changes in interest rates, can affect the selling price of the bond and consequently the yield.
When market interest rates increase, the price of existing bonds with lower interest rates drops below face value to adjust the yield upwards to the new market rates. In contrast, if market interest rates decrease, bonds with higher coupon rates than the current market rate become more valuable, selling above face value to equate the yield to the new lower market rates.