CPA Exam - FAR (Financial Accounting and Reporting)Select TransactionsEasy
A company issues 10-year, $1,000,000 bonds with a stated interest rate of 5%, payable semi-annually. The market interest rate on the date of issuance is 6%. Which of the following statements is true regarding the issuance of these bonds?
- AThe stated interest rate will be adjusted to the market interest rate.
- BThe bonds will be issued at par value.
- CThe bonds will be issued at a premium.
- DThe bonds will be issued at a discount.
Show answer & explanationAnswer & explanation
Correct answer: D. The bonds will be issued at a discount.
When the stated interest rate (5%) is lower than the market interest rate (6%), investors demand a higher return than the bond's coupon payments offer. To compensate for this lower stated rate, the bonds must be issued at a price below their face value, which is a discount.
Why the other options are wrong
- A. The stated interest rate is fixed at issuance and is not adjusted to the market rate; the price of the bond adjusts instead.
- B. Par value occurs when the stated interest rate equals the market interest rate.
- C. A premium occurs when the stated rate is higher than the market rate.
Bond Issuance Price
The price at which a bond is sold, determined by comparing its stated interest rate to the prevailing market interest rate.
- Issued at par when stated rate = market rate.
- Issued at a premium when stated rate > market rate.
- Issued at a discount when stated rate < market rate.
Memory trick: Compare the rates, determine the price fate.