Question

Viviano Corporation issued a new bond, and hired your bank as its underwriter. In an upcoming talk with its CFO, you are expected to explain the effect of market interest rate. An increase in the market rate of interest will have which one of the following effects on this bond?
a. increase the coupon rate
b. decrease the coupon rate
c. increase the market price
d. decrease the market price
e. increase the time period

Answer 1

Answer: d. decrease the market price

Explanation:

Interest rates and the prices of bonds are negatively correlated as one increasing means that the other is decreasing.

The reason is this: when market interest rates rise, investors will move away from bonds to other investments because bonds offer a fixed payment and so will be less attractive than other investments which would be offering higher returns based on the higher market rates.

The drop in demand for bonds will lead to their prices falling as per the rules of demand and supply.