Question

Bond interest paid is?

1) higher when bonds sell at a discount.
2) lower when bonds sell at a premium.
3) the same whether bonds sell at a discount or a premium.
4) higher when bonds sell at a discount and lower when bonds sell at a premium.

Answer 1

Bond interest paid is higher when bonds sell at a discount and lower when they sell at a premium because discounts reflect higher current market rates than the bond's rate, while premiums reflect lower current market rates. The correct option is 4.

Step-by-step explanation:

Bond interest paid is higher when bonds sell at a discount and lower when bonds sell at a premium. This is because when a bond is sold at a discount, it means that the market interest rates have increased since the bond was issued, and the bond’s fixed interest payments are now less attractive compared to newer bonds.

Therefore, the bond’s price is reduced to make it competitive, but the actual interest payment remains the same, leading to a higher yield for the buyer.

Conversely, when a bond sells at a premium, it indicates that the market interest rates have decreased since the issuance, making the bond's fixed interest payments more attractive. So, the bond’s price is increased, but the interest paid is still based on the face value, resulting in a lower yield to the buyer. The correct option is 4.