Final answer:
Bonds with stated interest rates higher than market rates sell at a premium; those with lower rates sell at a discount. For example, Required Valley's bonds at 7% will sell at a premium when the market rate is 6%. A simple $3,000 bond at 8% will be worth less if the market rate rises to 11%, and it will then sell at a discount.
Step-by-step explanation:
If Required Valley issued $300,000 of bonds with a stated interest rate of 7 percent, and at the time of issue, the market rate of interest for similar investments was 6 percent, then these bonds will sell at a premium. Because the bond's stated interest rate is higher than the prevailing market interest rate, investors are willing to pay more than the face value to receive the higher interest payments.
Now, consider a different scenario with a simple two-year bond issued for $3,000 at an interest rate of 8%. With the discount rate also at 8%, the present value of this bond equals its face value, since the bond's rate matches the discount rate. However, if interest rates rise and the discount rate is 11%, the present value of the same bond decreases, indicating it would be sold at a discount because its stated rate is less attractive compared to new bonds issued at the higher prevailing rate.
Using the case of a $10,000 ten-year bond at a 6% interest rate, if you are considering buying this bond one year before its maturity but the market interest rate has risen to 9%, you would expect to pay less than $10,000 for the bond. The calculation for its present value, given the new interest rate, would confirm the exact amount you should be willing to pay.