Question

A new bond issue that offers an 8% stated interest rate, while bonds of similar risk return 10%, will sell at:

a) A premium
b) A discount
c) Face value
d) Cannot be determined
e) None of the above

Answer 1

A new bond issue that offers an 8% stated interest rate, while bonds of similar risk return 10%, will sell at: b) A discount.

Step-by-step explanation:

When interest rates rise, the value of existing bonds with lower interest rates decreases. In this case, the 8% bond is offering a lower interest rate compared to other bonds with 10% interest rates. As a result, investors will demand a higher interest rate for the 8% bond in order to make it attractive. The bond will be sold at a discount, which means at a price lower than its face value, to compensate for the lower interest rate.

For example, if the bond's face value is $1,000, it may be sold for $900 to provide a higher effective interest rate to the investor. So therefore the bond will sell at a discount, the correct answer is b) A discount.