Zero-coupon bonds don't yield periodic interest payments. Instead, purchaser purchases bond for less than face value and is paid full face value when bond is due (maturity). Before bond matures, its market value (price paid by a purchaser in bond market) is determined by prevailing market interest rate.
For instance, holder of the 15-year bond with the face value of $1000 will get $1000 when bond matures in 15 years. Though, the present market value of bond is less than $1000. Difference between market value and face value reflects interest earned by holding bond to maturity. Below, let 15-year bond with face value of $1000.
(a) Find present market value of bond if prevailing market interest rate is 5% per year.
(b) Find prevaling market interest rate if current market value of bond is $300.
(c) Explain relation between present market value of bond and prevailing market interest rate. What occurs to market value of bond when market interest rate increases?