For each of the following independent situations, determine,(a) whether the bond
ID: 2433287 • Letter: F
Question
For each of the following independent situations, determine,(a) whether the bonds sold at face (maturity) value, at a premium(more than face value), or at a discount (less than face value),and (b) whether interest expense recognized each year for the bondswas less than, equal to, or greater than the amount of interestpaid on the bonds. a. Bonds with a stated rate of 8% were sold to yield aneffective rate of 9%. b. Bonds with a stated rate of 12% were sold to yield aneffective rate of 9%. c. Bonds with a stated rate of 9% were sold to yield aneffective of 9%. For each of the following independent situations, determine,(a) whether the bonds sold at face (maturity) value, at a premium(more than face value), or at a discount (less than face value),and (b) whether interest expense recognized each year for the bondswas less than, equal to, or greater than the amount of interestpaid on the bonds. a. Bonds with a stated rate of 8% were sold to yield aneffective rate of 9%. b. Bonds with a stated rate of 12% were sold to yield aneffective rate of 9%. c. Bonds with a stated rate of 9% were sold to yield aneffective of 9%.Explanation / Answer
Answer:
(a) whether the bonds sold at face (maturity) value, at apremium (more than face value), or at a discount (less than facevalue)
In “a” Bond will be sold at premium i.e. morethan face value, because the stated or quoted rate, which is alsoknown as yield to maturity (YTM) is lower than coupon rate which is9%. As in the formula of calculating bond price, stated rate is indenominator, and it divides the numerator, hence smaller thisstated rate as compared to coupon rate (effective yield rate) willhigher the price, i.e. above par value.
In “b” Bond will be sold at discount i.e. lessthan its face value. As the stated rate is 12% which is greaterthan coupon or effective yield rate, so it will discount more, andhence smaller the price of the bond as compared to par value, i.e.below par or face value.
In “c”, as both interest (stated) rate and coupon rateare same i.e. 9%, therefore, price of the bond will be equal to itspar value. And it will be equal at any point in time if both ratesheld constant for that time period. So finally the bond will besold at maturity or face or par value.
(b) whether interest expense recognized each year for the bondswas less than, equal to, or greater than the amount of interestpaid on the bonds
In “a” the bond is a premium bond, coupon payments aregreater that’s why it is selling above par, so interestexpense recognized each year for the bond is less than actuallypaid to the investors.
In “b” the bond is a discount bond, coupon payments aresmaller and it is selling below par, so interest expense recognizedearlier for each bond was greater than actually paid (which isless) to the investors.
In “c” as both rates are same, therefore, both interestrecognized and actually paid will be equal.
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