Question

If I buy a bond at a discount, the par value will be ____ than the original cost?

1) greater
2) less
3) equal
4) cannot be determined

Answer 1

When a bond is bought at a discount, its par value will be greater than the purchase price. This scenario occurs when the bond's coupon rate is less than the current market interest rate, necessitating a lower selling price to attract investors.

Step-by-step explanation:

If you buy a bond at a discount, the par value will be greater than the original cost. This happens when the market interest rate is higher than the bond's coupon rate, making the bond less attractive to investors, thus forcing the seller to offer the bond at a price lower than its par value to compensate for the lower interest earnings.

For example, consider a bond with a par value of $1,000 and a coupon rate of 8% when the market interest rate is 12%. This bond would be sold at a discount because its fixed interest payments are less attractive compared to the new bonds in the market offering 12%. To make this bond competitive, the price is reduced so that the yield to the investor aligns with current market rates.