Final answer:
The value of a 10% $1,000 coupon bond will be less than face value when the market interest rate is above 10%. This reflects the inverse relationship between bond prices and market interest rates, as existing bonds must compete with new bonds and other investments offering higher returns.
Step-by-step explanation:
For a 10% $1,000 coupon bond, when the market interest rate is greater than 10%, you would expect the value of the bond to be less than its face value. As interest rates rise, bonds with coupon rates lower than the prevailing market rates become less attractive to investors, causing these bonds to sell for less than their face value. Conversely, when market interest rates fall below the bond's coupon rate, the bond would be more valuable and sell for more than face value. This phenomenon reflects an inverse relationship between bond prices and market interest rates.
Consider a scenario where the market interest rate is 12%. You would compare the interest payments of this bond with an alternative investment that also yields a 12% return. For instance, an investment of $964 at 12% interest would grow to $1,080 in one year. Since you can achieve this with a $964 investment elsewhere, you would not want to pay more than $964 for the bond, which promises the same $1,080 return (consisting of the last year's $80 interest payment plus the $1,000 face value).