Question

Ace Co. owns a deep-discount bond, meaning all principal and interest is paid together by the borrower in a single lump-sum at maturity. The bond has a total maturity value of $500,000. Ace paid $354,832 (rounded) for the bond on the date it was issued (December 31, 2019) by Kings Co. The bond’s annual interest rate (the discount rate) is 7.1%, compounded annually and it matures five years from the date it was issued.

1. What amount would Ace have been willing to pay for the bond, had it determined that the appropriate discount rate on the bond was 8.2% at the issue date?
2. What amount would Ace have been willing to pay for the bond, had it determined that the appropriate discount rate on the bond was 6.1% at the issue date?
3. What does the discount rate reflect about a deep-discount bond?

Answer 1