Question

On July 1, 2016, $8 million face amount of 6%, 10-year bonds were issued. The bonds pay interest on an annual basis on June 30 each year. The market interest rates were slightly lower than 6% when the bonds were sold. Required:

(a.) How much interest will be paid annually on these bonds?

(b.) Were the bonds issued at a premium or discount? Explain.

(c.) Will the annual interest expense on these bonds be more than, equal to, or less than the amount of interest paid each year? Explain your answer.

Answer 1

[a]

Annual Interest paid = $ 8 million x 6%
= $ 480,000 [ $0.48 millions]

[b]
Bonds are issued at PREMIUM.
>This is because market rate is LESS than coupon rate.
>This means that investor would receive MORE interest if he invested in bonds rather than if he invested in market.
>That’s why the issuer charges ‘premium’ for extra interest to be paid to investor.

[c]
Interest Expense will be LESS than actual amount of interest paid.
This is because interest expense is calculated on the basis of market rate which is LOWER than coupon rate.