If a bond’s coupon rate is equal to the market rate of intrest, then the bond will sell:
The correct answer and explanation is:
Correct Answer: At par (or face value)
Explanation (Approx. 300 Words):
A bond is a financial instrument that represents a loan made by an investor to a borrower, typically a corporation or government. The bond has key features including its face value (par value), coupon rate, and maturity date.
The coupon rate is the interest rate the bond issuer agrees to pay bondholders annually, based on the bond’s face value. The market interest rate (also called the yield or required rate of return) is the prevailing rate investors demand for similar bonds in the market.
When a bond’s coupon rate equals the market interest rate, the bond is said to be sold at par. This means the price of the bond equals its face value (commonly $1,000 for corporate bonds).
Why does this happen?
- If the coupon rate = market rate, the income (coupon payments) an investor earns on the bond matches the return they could earn elsewhere with a similar risk profile.
- Therefore, investors are indifferent between this bond and others in the market, and they are willing to pay exactly the face value for it.
Comparison:
- If the coupon rate > market rate, the bond is more attractive and will sell at a premium (above par).
- If the coupon rate < market rate, the bond is less attractive and will sell at a discount (below par).
Example:
Suppose a bond has a face value of $1,000, a 6% annual coupon rate, and the market interest rate is also 6%. The bond pays $60 annually in interest. Since this matches what investors expect to earn from similar risk investments, the bond will sell for $1,000—its par value.
In conclusion, when a bond’s coupon rate equals the market rate of interest, the bond will sell at par, ensuring a fair value for both issuer and investor.