Securities Industry Essentials (SIE) ExamUnderstanding Products and Their RisksHard
A newly issued 5% corporate bond with a par value of $1,000 is currently trading in the secondary market. If prevailing interest rates for similar bonds have risen to 6%, what would be the approximate market price of this bond?
- A$833
- B$900
- C$1,050
- D$1,000
Show answer & explanationAnswer & explanation
Correct answer: A. $833
When prevailing interest rates rise above a bond's coupon rate, the bond will trade at a discount. The approximate price can be found by dividing the annual coupon payment by the new prevailing interest rate ($50 / 0.06 = $833.33).
Why the other options are wrong
- B. This is a plausible distractor, but not the closest approximation using the simplified calculation.
- C. This would indicate the bond is trading at a premium, which happens when rates fall.
- D. This would be the price if prevailing rates were 5%.
Bond Price & Interest Rate Relationship
Bond prices move inversely to interest rates. When rates rise, existing bond prices fall to offer a competitive yield; when rates fall, prices rise.
- Inverse relationship between bond prices and interest rates.
- When market rates > coupon rate, bond trades at a discount.
- When market rates < coupon rate, bond trades at a premium.
Memory trick: Rates Rise, Prices Plunge; Rates Recede, Prices Progress.