Question

When the market interest rate increases, a price of coupon bond

a) increases.
b) decreases.
C) does not change.
d) either increases or decreases
e) depending on the maturity of the bond.

Answer 1

When the market interest rate increases, the price of a coupon bond decreases.

Step-by-step explanation:

When the market interest rate increases, the price of a coupon bond decreases.

This is because coupon bonds pay a fixed interest rate, known as the coupon rate, which is determined when the bond is issued. When market interest rates rise, new bonds with higher coupon rates become available, making existing bonds with lower coupon rates less attractive to investors. As a result, the price of the bond decreases to compensate for the lower interest payments compared to newly issued bonds.

For example, if a bond was issued with a coupon rate of 3% and market interest rates rise to 4%, investors would prefer to buy new bonds with a coupon rate of 4% rather than hold onto the older bond with a lower coupon rate. The price of the existing bond would decrease to make it more attractive in comparison to newly issued bonds.