Bonds generally provide for periodic fixed interest payments at a contract rate of interest. At issuance, or thereafter, the market rate of interest for the particular type of bond may be above, the same, or below the contract rate. If the market rate exceeds the contract rate, the book value will be less than the maturity value. The difference (discount) will make up for the contract rate being below the market rate.
Conversely, when the contract rate exceeds the market rate, the bond will sell for more than maturity value to bring the effective rate to the market rate. This difference (premium) will make up for the contract rate being above the market rate. When the contract rate equals the market rate, the bond will sell for the maturity value.
The market value of a bond is equal to the maturity value and interest payments discounted to the present. Finally, when solving bond problems, candidates must be careful when determining the number of months to use in the calculation of interest and discount/premium amortization. For example, candidates frequently look at a bond issue with an interest date of September 1 and count 3 months to December 31. This error is easy to make because candidates focus only on the fact that September is the ninth month instead of also noting whether the date is at the beginning or end of the month.
The issue price of bonds is equal to the present value (PV) of the maturity value plus the PV of the interest annuity. The PV must be computed using the yield rate. The computation is
Amount PV Factor PV
$1,000,000 × .386 = $386,000
80,000 × 6.145 = 491,600
Total issue price $877,600
The interest amount above ($80,000) is the principal ($1,000,000) times the stated rate (8%).
Play Casino Games Online Conversely, when the contract rate exceeds the market rate, the bond will sell for more than maturity value to bring the effective rate to the market rate. This difference (premium) will make up for the contract rate being above the market rate. When the contract rate equals the market rate, the bond will sell for the maturity value.
The market value of a bond is equal to the maturity value and interest payments discounted to the present. Finally, when solving bond problems, candidates must be careful when determining the number of months to use in the calculation of interest and discount/premium amortization. For example, candidates frequently look at a bond issue with an interest date of September 1 and count 3 months to December 31. This error is easy to make because candidates focus only on the fact that September is the ninth month instead of also noting whether the date is at the beginning or end of the month.
The issue price of bonds is equal to the present value (PV) of the maturity value plus the PV of the interest annuity. The PV must be computed using the yield rate. The computation is
Amount PV Factor PV
$1,000,000 × .386 = $386,000
80,000 × 6.145 = 491,600
Total issue price $877,600
The interest amount above ($80,000) is the principal ($1,000,000) times the stated rate (8%).
