Final answer:
When a bond purchased for $952 increases in price to $1,072, it means the bond is experiencing a capital gain. This gain happens when the bond's market value rises due to factors such as a drop in prevailing interest rates, making its fixed coupon rate more attractive. The coupon rate stays the same, but the market price fluctuates, affecting the bond's total yield or return. The correct option is A.
Step-by-step explanation:
In the context of a bond investment, when a bond is purchased for $952 with a coupon rate of 5.80%, matures in 9 years, and a year later, the bond price is $1,072, it means the bond is experiencing a capital gain. This capital gain occurs because the value of the bond on the market has increased from the price at which it was originally purchased.
The coupon rate of 5.80% remains the same and provides regular interest payments to the bondholder; however, market conditions such as changes in prevailing interest rates can affect the bond's price. For instance, if interest rates in the economy decline, the bond's higher coupon rate becomes more attractive, causing the bond's market price to rise above its face value, hence creating a capital gain for the bondholder.
Conversely, if interest rates rise, the bond would be less attractive, and its price could fall below the original purchase price or face value, leading to a capital loss.
When considering the total return, the investor looks at both the interest payments (coupon payment) and any capital gains or losses. The yield on the bond can be calculated by considering the total amount received from the investment (including interest payments and return of face value at maturity) minus the purchase price, divided by the purchase price.
The example provided shows a scenario where a bond with an 8% coupon rate and a face value of $1,000 would be sold at a discount to yield a 12% return if market interest rates rise to that level, indicating that current bond prices adjust according to market conditions.