Question

St. Anywhere Medical Center issued $20 million in bonds at 5% with a 20-year maturity. What is the total amount of interest that will be paid on this debt, assuming that the bonds are held until maturity?

A) $5 million
B) $10 million
C) $15 million
D) $20 million

Answer 1

The total amount of interest paid on a $20 million bond at 5% over 20 years is $20 million. For the example provided, when the prevailing interest rates rise, one would expect to pay less than the face value of a bond that was purchased with a lower interest rate.

Step-by-step explanation:

The question asks about the total amount of interest that will be paid on a $20 million bond at 5% with a 20-year maturity. To calculate the total amount of interest, you would multiply the annual interest payment by the number of years the bond is held. The annual interest payment is 5% of $20 million, which is $1 million. Over 20 years, the total interest paid would be 20 times $1 million, resulting in a total of $20 million in interest payments.

Now, considering the provided example of a local water company bond issued at 6% interest with current rates at 9%, a buyer would expect to pay less than the face value for the bond. The last year's interest payment on this $10,000 bond would be $600. If the current interest rate is 9%, a new bond would pay $900 on a $10,000 investment. To match this, the current bond must be discounted by the difference in interest ($300), so you would be willing to pay $10,000 - $300 = $9,700.