Final answer:
On a skip-day settlement, a U.S. Government bond would typically be paid for two business days after the trade date. When interest rates rise, existing bonds with lower rates decrease in value. A $10,000 ten-year bond at 6% interest would be worth less than its face value if rates rise to 9%, with only a year left till maturity.
The correct option is b. 2
Step-by-step explanation:
A U.S. Government bond is sold to a customer on a skip-day settlement, which means the bond will be paid for delivery after a specified number of business days beyond the standard settlement period. For U.S. Treasury securities, the standard settlement period is the next business day. However, with skip-day settlement, this can be extended. Since the question does not specify the exact number of skip days, typically, a skip-day settlement might mean an additional day is added. Therefore, if we assume one skip day, the bond would likely be paid for two business days after the trade date.
Concerning the pricing of bonds and interest rates, when interest rates rise, the price of existing bonds with lower interest rates generally falls. This is because new bonds are likely to be issued with higher interest rates to reflect the current market, making older bonds with lower rates less attractive unless they are sold at a discount. Therefore, if the market interest rate rises above the bond's coupon rate, as it did from 6% to 9% in the provided scenario, you would expect to pay less than the face value for the bond.
To determine the price you would be willing to pay for a $10,000 ten-year bond at 6% interest when rates have risen to 9% and there is only one year left to maturity, you would calculate the present value of the bond's future cash flows (which include the final interest payment and the principal repayment) discounted at the new market rate of 9%. This would be less than the face value of the bond since the discount rate is higher than the coupon rate.
The correct option is b. 2