If interest rates in the overall economy increase to 8 percent,which one of the following is most likely to be the market value of a $1,000 corporate bond with a fixed interest rate of 7 percent?
A)$0
B)$1,100
C)$900
D)$1,000
E)$1,300

Question

Quizplus · Accepted Answer

When interest rates in the economy increase, the market value of existing bonds generally decreases. This is because new bonds with higher interest rates become available, reducing the demand for existing bonds with lower interest rates. In this case, the fixed interest rate of the $1,000 corporate bond is lower than the current interest rate in the economy. As a result, its market value is likely to decrease. A decrease of around 10 percent is a reasonable estimate, so the market value of the bond is likely to be around $900. Option C is the closest to this value. Option A and B are too extreme, while option D and E assume that the market value remains the same or increases, which is unlikely given the increase in interest rates.

If Interest Rates in the Overall Economy Increase to 8