State Street Beverage Company issues $802,000 of 11%, 10-year bonds on Ma rch 31

Question

State Street Beverage Company issues $802,000 of 11%, 10-year bonds on Ma rch 31, 2017. The bonds pay interest on March 31 and September 30. Which of the following statements is true? A. If the market rate of interest is 12%, the bonds will issue above par B. If the market rate of interest is 12%, the bonds will issue at a premium. ° C. If the market rate of interest is 12%, the bonds will issue at pa. 0 D. If the market rate of interest is 12%, the bonds will issue at a discount Click to select your answer

Explanation / Answer

The bond price is determined by the prevalent market rate. If the market rate is higher than the coupon rate offered by the bond, there is likely to be less demand for the bond (obviously, the investor will choose a bond that will be issued at a market rate or higher), this would mean, that given the lower demand, the price of the bond would fall and will be trading at a discount. If the bond's coupon rate is higher than the prevalent market rate, then the bond would trade at a premium.

IN the above scenario, the coupon rate is 11% and the market rate is 12%, investors will prefer to invest in a bond that offers coupon rate that is equal or higher than the market rate, hence the demand for the bond with coupon rate 11% will be low, which means that the bond will be issued at a discount. Option 4 - If the market rate of interest is 12%, the bonds will issue at a discount is correct.

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