Question

On January 1, Year 1. a company issues $100.000 of 8% bonds maturing in 10 years when the market rate of interest is 9%. The bonds were issued at a discount. Market interest rates drop to 6% by December 31, Year 2. The company retires these bonds on December 31, Year 2. Which of the following is true?

a) The bonds can be retired at their carrying value
b) The company will incur a loss
c) The company will incur again
d) No gain or loss will be recorded

Answer 1

b) The company will incur a loss

Step-by-step explanation:

The market rate at the time of issue = 9%, while coupon rate = 8%, it says bonds provide lesser return when compared to the market rate.

At end of year 2 market rate drops to 6% which is lower than the Bond's coupon rate. Which means the bond's providing high return when compared to the market. So, company to retire the bonds need to pay more than the par value.

As company should retire these bonds more than par value, the company incur a loss.

Option 'B is correct

The company incur a loss