If the market interest rate is 7%, what type of bond price can Nooks expect for the bonds?

Question

Nooks is planning to issue $470,000 of 5%, 10 year bonds payable to borrow for a major expansion. The owner, Simon Nooks, asks your advice on some related matters.

 

If the market interest rate is 7%, what type of bond price can Nooks expect for the bonds?

 

 

I have to choose one of the three

-Face Value 

-Discount Value

-Premium Value

Answer 1

The sales price for a bond is influenced by the relationship between the market rate of interest and the contract rate of interest. 

 

If the market rate is equal to the contract rate, the bonds will sell for their face value.

 

If the market rate of interest is less than the contract rate, the bonds will sell for more than their face value.  This is called a premium.  This is because buyers are willing to pay more because the bonds pay a higher rate of interest than other bonds in the market.

 

If the market rate is greater than the contract rate, the bonds will sell for less than their face value.  This is called a discount.  This is because buyers are not willing to pay as much for the bonds since the bonds don't pay as much interest as other bonds in the market. 

 

So in this case since the market rate of 7% is greater than the contract rate of 5%, the bonds will sell at a discount.