Final answer:
The amount of discount amortized each interest period under the effective-interest method is the interest expense less the cash paid. A bond's present value is calculated using the future cash flows and the current discount rate. This value will change if the market interest rates vary, leading to interest rate risk for bond investors.
Step-by-step explanation:
Under the effective-interest method of amortization, the amount of discount amortized each interest period is equal to the amount of interest expense less the cash paid. This method results in a gradually increasing amount of discount amortization as the carrying amount of the bond approaches its face value over time.
When considering a simple two-year bond issued for $3,000 at an 8% interest rate, the bond will pay $240 in interest annually. To calculate the present value of this bond at an 8% discount rate, you would discount the future cash flows of interest and principal payments back to their current worth using the present value formula provided.
If the discount rate increases to 11%, the present value of the bond would decrease, illustrating the interest rate risk associated with bond investments. A bondholder receiving fixed interest payments would incur an opportunity cost when market interest rates rise, as new bonds offer higher yields.