Question

what would you do in each scenario

coupon rate < market rate

coupon rate > market rate

coupon rate = market rate

explain what action you would take and why

Answer 1

Coupon rate is smaller than market rate:

Action: bond would be issued at discount.

Reason: since the market rate is higher, the bond would be attractive in the market if its price is lower than the face value, called discount.

Coupon rate is higher than market rate:

Action: bond would be issued at premium.

Reason: since the market rate is lower, the bond is already demanded in the market. Investors would get higher return if they invest in the bond and they would be ready to pay higher price. This is why the bond would be issued at a price more than its face value, called premium.

Coupon rate is equal to market rate:

Action: bond would be issued at par.

Reason: since there is no difference of return, investors would not willing to pay premium price or don’t demand for discount price. The price of bond would be at its face value, called at par.