Final answer:
An individual owning a $1,000 bond with a 3.97% interest rate receives $39.70 annually. The price of bonds fluctuates based on market interest rates. When the market rate exceeds a bond's coupon rate, its price decreases to bring the yield in line with current rates.
Step-by-step explanation:
The annual dollar amount of interest that one receives from a $1,000 corporate bond that pays 3.97 percent is calculated by multiplying the bond face value with the interest rate. So, the calculation would be $1,000 x 0.0397 = $39.70. This figure represents the interest payment received every year.
Calculating Bond's Price with Different Market Interest Rates
When a bond's coupon rate is less than the current market interest rate, its price will decrease. For example, if the expected payments from a bond one year from now are $1,080 (which includes the last year's interest and the principal repayment), and current rates are 12%, an investor could make an alternative investment of $964 to receive $1,080 in a year, because $964 x 1.12 = $1,080. Thus, the original $1,000 bond would not sell for more than $964.
If we think about a two-year bond, initially issued at $3,000 with an 8% interest rate, it would pay $240 in interest each year. The present value of this bond would be different based on whether the discount rate is 8% or has risen to 11%. The discount rate reflects the current market interest rates, which affects the bond's present value.