Final answer:
If Bert invests in bonds with a coupon rate lower than the current market YTM, he would be buying the bonds at a discount, paying less than the face value. This discount compensates for the bond's lower coupon rate relative to the current market rates, ensuring that the bond's yield aligns with market expectations.
Step-by-step explanation:
If Bert invests in bonds when the coupon rate is currently less than the market yield to maturity (YTM), he would be purchasing the bonds at a discount. This means Bert can expect to pay less than the bond's face value. When the market interest rates are higher than the coupon rate of a bond, the bond's price falls below its par value, and it sells at a discount to attract buyers.
For example, if the expected payments from a bond one year from now are $1,080 (the bond's face value of $1,000 plus an $80 coupon payment), and the current market interest rate is 12%, investors would not pay more than $964 for the bond. This is because $964 invested at the new market rate of 12% would also grow to $1,080 in one year. Therefore, the price of the bond adjusts such that its yield matches the prevailing market rates.