Final answer:
The discount rate is an interest rate used to calculate the Present Discounted Value of a bond, making the present value of the bond's future payments equal to its current market price.
Step-by-step explanation:
The discount rate that makes the present value of a bond's payments equal to its price is the interest rate used in the Present Discounted Value (PDV) calculation. PDV is the current worth of a future sum of money or stream of cash flows given a specified rate of return.
If a bond is issued at $3,000 with an 8% interest rate, then the present value of this bond is also $3,000, assuming that 8% is the prevailing market discount rate.
For example, if you are receiving a payment of $110 in one year, and the discount rate is 10%, then the present value or PDV of that future payment would be $100. This means you would be indifferent between having $100 now or $110 in one year, given a 10% discount rate. The discount rate aligns the future cash flows of the bond—interest payments and face value repayment—with its current market price.