Final answer:
The correct answer to the bond pricing problem when interest is compounded quarterly is to decrease the interest rate and increase the years of maturity. This accounts for the frequency of compounding affecting the periodic interest rate and the total number of compounding periods over the life of the bond.
Step-by-step explanation:
When a bond pricing problem indicates that interest is compounded quarterly, you must adjust the interest rate and the years of maturity accordingly. Specifically, you need to decrease the interest rate and increase the years of maturity for the purpose of the calculation. This is because when interest is compounded more frequently, each period's interest rate is a fraction of the annual rate, and the number of compounding periods is the number of years multiplied by the frequency of compounding.
For example:
- If the annual interest rate is 8% and interest is compounded quarterly, the quarterly interest rate would be 2% (which is 8% divided by 4).
- If the bond matures in 10 years, there would be 40 compounding periods (10 years multiplied by 4 quarters per year).
In bond pricing problems, these adjustments ensure the calculations are accurate for the given compounding frequency.