You pay $10,000 for a one-year bond with a $10,000 original value and a single fixed payment of $400 at the end of the year. You hold the bond until the year is up, but during that time, the market price of the bond falls to $8,000. The interest rate on your investment will be 5 percent.

Question

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The market price of the bond falling to $8,000 means that if you were to sell the bond before the end of the year, you would receive only $8,000 instead of the original $10,000. However, since you are holding the bond until the year is up, you will still receive the full $400 payment at the end of the year, which represents a 4% return on your original investment of $10,000. This is lower than the 5% interest rate you were promised, but it still means that you are earning a positive return on your investment.

You Pay $10,000 for a One-Year Bond with a $10,000