Why does a bond sell at a discount when the coupon rate is lower than the required rate of return and vice
versa?
What will be an ideal response?
The market value of a bond, as the value of any financial asset, is the present value of the future cash flows the bond is
expected to provide. Usually, the coupon rate (thus coupons) is set equal to the going interest rate when the bond is
issued making the bond to sell at a price equal to the par value. However, interest rates change over time but the
coupon rate remained fixed (i.e. fixed income securities). The price of a bond, or market value, will be less than the par
value if the required rate of return of investors is above the coupon interest rate; but it will be valued above par value if
the required rate of return of investors is below the coupon interest rate.
If the bond sells at a discount below par value, it is called a discount bond. If the bond sells at a premium above par
value, it is called a premium bond.
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