Final answer:
If interest rates are expected to fall, you should purchase a 10-year zero-coupon bond. With interest rates increasing from 6% to 9%, you would pay less than $10,000 for the bond due to the higher current market rate. The amount you would be willing to pay can be determined by discounting the bond's future cash flows at the new interest rate.
Step-by-step explanation:
If you believe that interest rates will fall, you should ideally purchase a 10-year zero-coupon bond. This type of bond typically experiences a higher price increase compared to coupon bonds when interest rates fall, because the bond's single payment at maturity is discounted at the lower current rate, leading to a higher present value increase.
Regarding the scenario described about the local water company's $10,000 ten-year bond at a changed interest rate from 6% to 9%, you would expect to pay less than $10,000 for the bond. This is because the bond's fixed interest rate is now lower than the current market rate, and as a result, the bond's price must decrease to provide a yield to maturity that is competitive with the new 9% market rate.
To calculate what you would be willing to pay for the bond, you would discount the bond's remaining cash flows, which include the final year's interest payment and the principal repayment, at the new interest rate of 9%. If the bond is a typical coupon bond paying annual payments, you would calculate the present value of the remaining cash flows using the new yield to maturity.