Question

In: Accounting

At the date of issue, bond buyers determine the present value of two cash flows, (1)...

At the date of issue, bond buyers determine the present value of two cash flows, (1) periodic interest payments during the life of the bond and (2) the principal paid at maturity, using the stated rate of the bond.

Select one:

True

False

Solutions

Expert Solution

The Correct answer would be True.

When an investor buys the bond the investor basically lends money to the issuer of bond. In return the issuer of the bond pays the Principal amount of bond at maturity and periodic interest payments for using the money provided to the bond issuer.

If we look at the formula for determining the Price of bond we can further understand the concept

Price of Bond = Cupon Amount * Present Value of Annuity Factor (r,n) + Redemption Amount * Present Value of Interest Factor (r,n)

So Price of bond has two parts

  • Cupon Amount * Present Value of Annuity Factor (r,n)
  • Redemption Amount * Present Value of Interest Factor (r,n)

Cupon rate is the interest rate paid by the issuer of bond. When we multiply Cupon rate with par value of the bond we get Cupon Amount. So this periodic interest payment is received by the buyer of the bond during its life.

Redemption Amount is known as the principal amount to be paid at maturity.

For both the cashflows we have to take Present Value as stated in the formula.

Therefore the buyers of the bond determine present value two cash flows as stated above and therefore it can be concluded that the answer to the question is True.

ekkarill92 answered 1 year ago
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