Question

A bond has a $1,000 par value, makes annual interest payments of $100, has 5 years to maturity, cannot be called, and is not expected to default. The bond should sell at a premium if market interest rates are below 10% and at a discount if interest rates are greater than 10%. (True/False)

Answer 1

True

Step-by-step explanation:

F= face/par value

C= redemption value

r= coupon rate

i= interest rate

As a general rule, F and C are assumed to be equal (unless stated otherwise)

if Fr-Ci is positive, then the bond was sold at a premium. If it's negative, then the bond was sold at a discount. Because F=C, we can simplify the equation to F(r-i). thus, if r>i then the bond was sold at a premium. if r<i the bond was sold at a discount.

In our question, r= .1 so if i>.1 the bond was sold at a discount and if i<.1 the bond was sold at a discount.