Question

1.If a bond sells at a premium,

(A)interest expense can not be calculated.

(B)cash interest will equal interest expense each period.

(C)interest expense exceeds cash interest each period.

(D)cash interest exceeds interest expense each period.

2.

A bond will sell at a discount when

(A)the stated rate is less than the market rate

(B)the stated rate is more than the market rate

(C)interest rates fall

(D)the company's stock price goes down

Answer 1

Answer : 1 (D) cash interest exceeds interest expense each period.

Why does the premium reduce interest expense? The amount of cash is based on the face rate of the bond. Because the bond purchasers paid extra for the bond, the company more money than the face value of the bond. That additional cash helps to offset the amount the company pays in effective interest. A portion of each cash payment is a return of the premium to the purchasers. This lowers the interest expense to the company.

2 (A)the stated rate is less than the market rate

If the market rate is higher than the stated rate, that means people are not willing to pay as much for the bonds. Either there is risk associated with the company or there are better investments elsewhere. In order to entice the public to buy the bonds, the company must offer a discount on the bonds.