Question

Your business associate mentions that she is considering investing in corporate bonds currently selling at a premium. She says that since the bonds are selling at a premium, they are highly valued and her investment will yield more than the going rate of return for the risk involved. Reply with a memorandum to confirm or correct your associate’s interpretation of premium bonds.

Answer 1

Answer:

Prepare the required memo in the following way :

To : Associate

From : ABC

Subject : interpretation of premium bonds

At the point when bonds are issued at a premium ,you have to pay more cash for the securities than the standard estimation or par value of the bonds .However ,the interest to be paid to the bondholders is determined as a rates of the standard worth or par value .This infers the successful interest rate that is the rate at which you get interest on your cash is lesser than the agreement rate .

For example , expect that you buy securities or bonds having par value of $ 1,00,000 and contract pace of 10% by paying $ 1,25,000 that is at a premium of $ 25,000.You will get $ 10,000 as interest at the pace or rate of 10% on the standard estimation of the bonds . Presently ,in the event that you compute the effective interest rate that is the rate at which you get interest on your cash $1,25,000 it comes to 8 %

Calculation of effective interest rate :

• Effective interest rate = $ 10,000/$ 1,25,000*100 = 8%

In this way when bonds are bought at premium ,the speculation doesn't yield more than the going rate of return for the risk involved.