Question
When overall interest rates rise to 10%the bond you already own with 5% coupon rate becomes
Answers
GPT-4o mini
When overall interest rates rise to 10%, the value of a bond that has a lower coupon rate (in this case, 5%) will decrease. This is because new bonds are being issued at the higher interest rate of 10%, making existing bonds with lower rates less attractive to investors.
Here’s a brief explanation of how this works:
1. **Coupon Rate**: The coupon rate is the interest rate the bond pays annually based on its face value. In this case, you have a bond with a 5% coupon.
2. **Market Interest Rates**: When current market interest rates increase to 10%, investors will prefer new bonds that pay 10% rather than your existing bond that only pays 5%.
3. **Price Adjustment**: To sell your 5% bond in this new market, you would need to sell it at a discount. This discount adjusts the yield of your bond to match the 10% yield available on new bonds.
4. **Yield Calculation**: The yield of a bond is calculated by taking the annual coupon payment and dividing it by the bond's current market price. If the bond's price falls sufficiently, the yield can align more closely with the new market rates.
In summary, as interest rates rise to 10%, the market value of your bond with a 5% coupon rate decreases, reflecting the lower relative value compared to new bonds with higher rates.
Here’s a brief explanation of how this works:
1. **Coupon Rate**: The coupon rate is the interest rate the bond pays annually based on its face value. In this case, you have a bond with a 5% coupon.
2. **Market Interest Rates**: When current market interest rates increase to 10%, investors will prefer new bonds that pay 10% rather than your existing bond that only pays 5%.
3. **Price Adjustment**: To sell your 5% bond in this new market, you would need to sell it at a discount. This discount adjusts the yield of your bond to match the 10% yield available on new bonds.
4. **Yield Calculation**: The yield of a bond is calculated by taking the annual coupon payment and dividing it by the bond's current market price. If the bond's price falls sufficiently, the yield can align more closely with the new market rates.
In summary, as interest rates rise to 10%, the market value of your bond with a 5% coupon rate decreases, reflecting the lower relative value compared to new bonds with higher rates.