Why might a bond trade at a discount?

A bond trades at a discount when its market price is below its face value. This typically happens when the bond's coupon rate is lower than the current prevailing market interest rates. Investors seek the best returns possible; if new bonds are issued at higher rates, existing bonds with lower rates become less attractive. Consequently, to entice buyers, the price of these lower-coupon bonds must decrease, causing them to trade at a discount.

Understanding the relationship between coupon rates and market interest rates is crucial for bond pricing. When market rates increase, existing bonds with lower rates must offer a lower price to remain competitive in the marketplace. Thus, the scenario described in the correct answer highlights a foundational principle of bond valuation in an interest rate environment.