Final answer:
If the market rate of interest drops, the value of a bond will increase because its fixed interest payments are more attractive compared to new lower market rates, making the bond more valuable to investors. If market interest rates rise, the value of existing bonds with lower fixed interest rates will decrease.
Step-by-step explanation:
If you own a bond currently valued at $989 and the market rate of interest drops, the bond's current market value will increase. This is because the bond's fixed interest payments become more attractive compared to the new lower interest rates available in the market, making the bond more valuable to investors seeking income. As a result, investors are willing to pay more for a bond with a higher interest rate than what is currently available, which drives up the price of the bond.
For instance, if you are considering whether you would pay more or less than $10,000 for the bond given the change in interest rates, the answer depends on the specifics of the bond's interest rate compared to the market rate. However, generally, if the bond's interest rate is higher than the market rate, it would be worth more than its face value (possibly more than $10,000). Conversely, if the bond's interest rate is lower than the market rate, it would be worth less than its face value.
Say that Ford has issued bonds with a certain interest rate, and a year later the market interest rate rises from 3% to 4%. In this situation, the value of the bond would decrease because the fixed payments from the bond would be less attractive compared to the new higher rates available elsewhere, leading investors to pay less for the bond.