Question

if bond coupon payment is lower than r, it’s called:

a) par bond

b) premium bond

c) discount bond

Answer 1

If bond coupon payment is lower than r, it's called " Discount bond"

Correct answer is (b) discount bond.

Explanation: A bond is called a discount bond if it is issued or trading for less than its par value or face value. In other words, we can say that the discount bonds is a bond currently trading for less than its face value in the market.

When the current market interest rate is higher than the interest rate being paid by the issuer of the bond, then in such case investors want to pay less for the bond in order to derive a higher effective interest rate on their investment. Hence, a bond will not trade at par if current interest rates are above or below the bond's coupon rate, which is the interest rate that is expected from the market.

For example, if the 1-year bond having Face Value of 1,000 with coupon 7% i.e 70 but the maeket return (r) is 10%. In such a case, the present value of the bond is 972.72 ( i.e 1070/1.10). It means the investor will pay only 972.72 for the bond having 1,000 and it is to be said that the bond is trading at a discount or its a discount bond.

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