Swanson Inc. purchased $400,000 of Malone Corp. ten-year bonds with a stated interest rate of 8 percent payable quarterly. At the time the bonds were purchased, the market interest rate was 12 percent. Determine the amount of premium or discount on the purchase of the bonds.

Question

Quizplus · Accepted Answer

When the market interest rate is higher than the stated interest rate of the bond, the bond is sold at a discount. To calculate the amount of discount, we first need to calculate the present value of the bond's future cash flows using the market interest rate.

n = 40 (10 years * 4 quarters per year)
i = 12/4 = 3% (market interest rate per quarter)
PMT = ($400,000 * 8%) / 4 = $8,000
FV = $400,000

PV = $8,000 * ((1 - (1 / (1 + 3%)^(40)))) / (3%) + (400,000 / (1 + 3%)^(40))
PV = $303,558

The purchase price of the bond is $400,000, so the discount is:

Discount = $400,000 - $303,558 = $96,442

Since the discount is greater than $0, we choose option B, which represents a $92,442 discount (rounded to the nearest thousand).