CPA Exam - FAR (Financial Accounting and Reporting)Financial ReportingEasy
A company issues a $1,000,000, 5-year bond with a stated interest rate of 6% payable annually. The market interest rate for similar bonds is 8%. Which of the following statements is true regarding the bond's issuance?
- AThe bond will be issued at face value.
- BThe bond will be issued at a discount.
- CThe bond will be issued at a premium.
- DThe carrying value of the bond will increase over its life.
Show answer & explanationAnswer & explanation
Correct answer: B. The bond will be issued at a discount.
When the stated interest rate (coupon rate) of a bond is less than the market interest rate (yield rate), the bond will be issued at a discount. Investors will not pay full face value for a bond paying a lower interest rate than they could get elsewhere.
Why the other options are wrong
- A. Face value issuance occurs when the stated rate equals the market rate.
- C. A premium occurs when the stated rate is higher than the market rate.
- D. If issued at a discount, the carrying value of the bond will increase towards face value over its life, not necessarily 'over its life' if it was issued at a premium. The question asks about issuance, not subsequent accounting.
Bond Issuance Price
The price at which a bond is issued is determined by comparing its stated interest rate (coupon rate) to the prevailing market interest rate (yield rate) for similar bonds.
- Stated Rate > Market Rate = Premium.
- Stated Rate < Market Rate = Discount.
- Stated Rate = Market Rate = Face Value.
Memory trick: RATE comparison sets the PRICE: High coupon, high price!