Accounting: Tools for Business Decision Making, 5th Edition

Published by Wiley
ISBN 10: 1118128168
ISBN 13: 978-1-11812-816-9

Chapter 10 - Reporting and Analyzing Liabilities - Questions: 14

Answer

The market price of the bond is determined from the market rate of interest. If the market rate of interest is lower than the contractual interest rate, investors will pay more than face value for the bonds. If the market rate of interest is more than the contractual rate of interest, the investors will resist investing, unless the bonds are issued at a discount to match the contractual rate of interest with market rate of interest. If a bond with contractual interest rate of 10% having face value 100 dollars is issued, and the market rate of interest is 12%, the investors will not be interested in buying this 10% bonds. Hence the value of the bond will fall, and the issue will be made at a discount.

Work Step by Step

Conversely, if the market rate of interest is 8%, and the bond's contractual rate of interest is 10%, more investors will be attracted to purchase the bonds, and so the price of the bonds will be higher than issue price. So the issue will be made at a premium.
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