As the market interest rate drops, a
Explanation :
In simple words, the bond's coupon is the rate of return that the investor will get periodically for investing in the bond. These coupon rates somehow determine the value of these fixed income securities by providing a competitive position of such bonds in the open market. The coupon rates are fixed at the initiation off the issuance of the bond and are calculated on the par value.
The coupon rates of the bonds is directly affected by the government securities interest rate, that is, if the government fixed the interest rate for its Treasuries at 7% the investor have the option to earn 7% rate of interest without any risk. Hence if any issuer issues its bonds below or at prevailing treasury rate the investor will invest in those bonds only if they are traded at discount, since there is a risk of default in such securities.
On the other hand, if the treasuries are trading at a 7% rate and the issuer issues its binds at 10% the investor will get the higher interest incentive. The bonds issued in past keep on trading in secondary market until their maturity, thus, in a scenario if a bond is issued in 2018 at 10% coupon rate with maturity in 2025 when interest rate was 9% and in 2020 the interest rate declines to 7% then the investors will get superior return by investing in the 2018 bonds leading to high price of such security.
Trending now
This is a popular solution!
Step by step
Solved in 2 steps
