Question

On July 1, 2020, Mayweather Inc. issued $600,000 of 10% bonds dated July 1. Interest is payable semiannually on June 30 and December 31. The bonds mature in five years, on June 30, 2025. Spymaster purchased the entire bond issued on a date when the market interest rate for bonds of similar risk and maturity was 12%.

a) True
b) False

Answer 1

The bond issued by Mayweather Inc. would be sold at a discount because its coupon rate is less than the market interest rate when purchased by Spymaster. Likewise, in the example provided, a bond with a coupon rate less than the market interest rate would also sell for less than its face value.

Step-by-step explanation:

The student's question revolves around bond valuation and interest rates in Corporate Finance, a business-related subject. When a company issues bonds, it is borrowing money from bondholders, promising to make regular interest payments and to repay the principal at maturity. The bonds' market value is influenced by the prevailing market interest rates. Since the bond issued by Mayweather Inc. has a coupon rate of 10% but the market rate at the time of purchase by Spymaster is 12%, this means that the bond would be issued at a discount, because investors could get a higher return elsewhere in the market.

Regarding the specific question about buying a bond with a different market interest rate than the bond's coupon rate:

• If a bond's coupon rate is lower than the market interest rate, it will sell for less than its face value (discount).
• If the coupon rate is higher than the market interest rate, it will sell for more than its face value (premium).

In the example where a water company issued a bond at 6% and the market rate is now 9%, the bond would sell for less than the face value because the interest rate that it offers (6%) is less attractive than the current market rate (9%).