A $100,000 5-year 7% bond is issued on January 1, 2020. The bond pays interest annually. The market rate is 5%. What is the selling premium or discount on the bonds, rounded to nearest dollar?
A)$8,659 premium
B)$8,200 premium
C)$8,659 discount
D)$8,200 discount

Question

Quizplus · Accepted Answer

The bond will sell at a premium because its coupon rate (7%) is higher than the market rate (5%). To calculate the premium, we need to find the present value of the bond's cash flows (interest payments and principal repayment) discounted at the market rate (5%). The interest payment is $7,000 annually ($100,000 * 7%), and the principal repayment is $100,000 at the end of 5 years. Using the present value formula for an annuity and a single sum, the total present value of the bond's cash flows exceeds its face value, resulting in a premium. The exact calculation requires financial calculator or spreadsheet software, but the correct answer based on the options provided is a $8,659 premium.

A $100,000 5-Year 7% Bond Is Issued on January 1