Final answer:
To find the yield on a bond when its coupon rate is below the market interest rate, you compare the expected payments from the bond to the amount you could earn from an alternative investment at the current market rate.
Step-by-step explanation:
Understanding Bond Pricing and Yield
Finding the interest rate or yield for a bond investment requires some basic bond valuation knowledge. When a bond's coupon rate is less than the market interest rate, the bond will sell for less than its face value. Conversely, when a bond's coupon rate is higher than the market interest rate, the bond will sell for more than its face value.
For instance, if you expect to receive $1,080 from a bond in one year, and the market interest rate is 12%, you would not pay more than $964 for that bond because $964 invested at a 12% interest rate would grow to $1,080 in a year. Therefore, the price you would pay for a bond when the market interest rate is 12% is $964, considering that the bond will pay out $1,000 in face value plus $80 in the last year's interest payment. This results in a yield of 12%.
In another scenario, if a $10,000 bond was issued at a 6% interest rate and you are considering buying it one year before maturity when the market interest rate is now 9%, you would have to calculate the current price of the bond based on the market rate to ensure that the yield on the bond meets the 9% market rate.