A bond will sell at a discount when the market, or effective, rate of interest is higher than the stated rate of interest on the bond. In contrast, when the market or effective rate of interest is lower than the stated rate, the bond will sell at a premium.
When a bond sells at a discount?
Bonds are sold at a discount when the market interest rate exceeds the coupon rate of the bond. To understand this concept, remember that a bond sold at par has a coupon rate equal to the market interest rate.
When a bond is trading at a discount the current yield on the bond is quizlet?
For premium bonds, the current yield exceeds the YTM; for discount bonds the current yield is less than the YTM; and for bonds selling at par value, the current yield is equal to the YTM. In all cases, the current yield plus the expected one-period capital gains yield of the bond must be equal to the required return.
When bonds sell at a discount It means that the selling price?
A discount bond is offered at a lower price than the prevailing market rate. Buying the bond at a discount means that investors pay a price lower than the face value of the bond. However, it does not necessarily mean it offers better returns than other bonds. Let take an example of a bond with a $1,000 face value.
What is the purpose of a bond discount quizlet?
What is the purpose of a bond discount? It raises the bond interest rate to the market interest rate at the time the bond was issued.
Is it better to buy a bond at discount or premium?
Bonds bought at a premium can actually help reduce volatility, generate greater cash flow, and even provide higher yields. A basic rule of thumb suggests that investors should look to buy premium bonds when rates are low and discount bonds when rates are high.
Why would someone buy a bond at a discount?
Interest Rates and Discount Bonds
A bond that offers bondholders a lower interest or coupon rate than the current market interest rate would likely be sold at a lower price than its face value. This lower price is due to the opportunity investors have to buy a similar bond or other securities that give a better return.
How can you calculate the current yield of a bond?
Calculating Current Yield
The current yield is equal to the annual interest earned divided by the current price of the bond. Suppose a bond has a current price of $4,000 and a coupon of $300. Divide $300 by $4,000, which equals 0.075. Multiply 0.075 by 100 to state the current yield as 7.5 percent.
When a bond is purchased at a discount the current yield will be?
When a bond is purchased at face value, the current yield is the same as the coupon rate. But let’s say the bond was purchased at a discount to face value – Rs 900. The current yield would be 6.6% (Rs 60/ Rs 900). This reflects the total return an investor receives by holding the bond until it matures.
What four variables are required to calculate the value of a bond?
The selling date, maturity date, coupon rate, redemption price, and market rate together determine the bond price. On the bond’s issue date, the market rate determines the coupon rate, so these two rates are identical.
What happens if I sell a bond before maturity?
When you sell a bond before maturity, you may get more or less than you paid for it. If interest rates have risen since the bond was purchased, its value will have declined. If rates have declined, the bond’s value will have increased.
How do you tell if a bond is selling at a premium or discount?
With this in mind, we can determine that:
- A bond trades at a premium when its coupon rate is higher than prevailing interest rates.
- A bond trades at a discount when its coupon rate is lower than prevailing interest rates.
How is a bond valued?
Bond valuation, in effect, is calculating the present value of a bond’s expected future coupon payments. The theoretical fair value of a bond is calculated by discounting the future value of its coupon payments by an appropriate discount rate.
How is bond premium treated for tax purposes?
If the bond yields tax-exempt interest, you must amortize the premium. This amortized amount is not deductible in determining taxable income. … As long as the bond is held to maturity, there will be no capital gain or loss associated with the bond.
When a bond is sold at premium then?
If a bond is trading at a premium, this simply means it is selling for more than its face value.
Under what situation might a bond discount arise when issuing bonds?
Discount on bonds payable occurs when a bond’s stated interest rate is less than the bond market’s interest rate. If a $1,000,000 bond issue promises to pay interest of 8% per year and the bond market demands 8.125%, the bonds will sell for less than $1,000,000.