Final answer:
The issuer sells a bond at less than its face value when market interest rates rise. This is because the bond's fixed rate is less attractive than new bonds with higher rates. To make the bond competitive, it is priced below face value.
Step-by-step explanation:
The issuer of a bond may sell it at less than the Face Value (FV) when the interest rates in the economy rise after the bond has been issued. This occurs because the bond, which has a fixed interest rate, becomes less attractive compared to new bonds that may be issued at the higher prevailing rates. Investors would not be willing to pay the full face value for a bond that pays lower interest, so the issuer must sell the bond at a discount to make it competitive. This concept is related to the present value calculation, where the future cash flows from the bond (interest payments and return of principal at maturity) are discounted back to their present value at the current market interest rates.
If there is no risk associated with the bond, it is generally expected to sell for its face value at issuance. However, as interest rates increase, the bond's price has to be adjusted downwards. For instance, if the market interest rate rises to 12% and a bond with a year until maturity offers an 8% rate, the price of the bond will be reduced from its face value to attract investors, compensating for the lower interest rate it provides.