CPA Exam - FAR (Financial Accounting and Reporting)Select TransactionsMedium
A company issues a 5-year, $1,000,000 bond with a stated interest rate of 6%, payable annually. The market interest rate at the time of issuance is 8%. Which of the following statements is true regarding the issuance of this bond?
- AThe bond will be issued at a premium.
- BThe bond will be issued at a discount.
- CThe bond will be issued at par value.
- DThe carrying value of the bond will remain constant over its life.
Show answer & explanationAnswer & explanation
Correct answer: B. The bond will be issued at a discount.
If the stated interest rate (6%) is less than the market interest rate (8%), the bond will be issued at a discount. Investors demand a higher return than the stated rate, so they will pay less than the face value.
Why the other options are wrong
- A. A premium occurs when the stated rate is higher than the market rate.
- C. A bond is issued at par when the stated rate equals the market rate.
- D. The carrying value of a bond issued at a discount or premium changes over its life as the discount or premium is amortized.
Bond Issuance Price
The issuance price of a bond is determined by comparing its stated interest rate to the prevailing market interest rate at the time of issuance.
- Stated Rate > Market Rate = Premium.
- Stated Rate < Market Rate = Discount.
- Stated Rate = Market Rate = Par Value.
Memory trick: BONDS are a PROMISE to pay, and their price depends on the MARKET's interest rate.