Question

A bond issue with a face amount of $502,000 bears interest at the rate of 7%. The current market rate of interest is 8%. These bonds will sell at a price that is:

Multiple Choice

More than $502,000.

Less than $502,000.

The answer cannot be determined from the information provided.

Equal to $502,000.

Answer 1

Correct answer is option b i.e. Less than $502,000.

Explanation:

As the market rate of interest is higher (i.e. 8%) as compared to the interest offered on the bonds issued (i.e. 7%), the present value of the bonds , if calculated, will always be less than the face value of the bonds at any given maturity period i.e. they will be issued at discount as the investor is getting the return which is less than the rate offered in the market, hence will pay less than the face value of the bonds to neutralize the effect.

And as the bonds are issued at discount it means they will be issued at the value that will be less than the face value i.e. $502,000 of the bonds.