Question

For the issuer of 20-year bonds, the amount of amortization using the effective interest method would decrease each year if the bonds are sold at:

Premium	Discount
a. No	Yes
b. No	No
c. Yes	Yes
d. Yes	No

Please explain why b is correct, I'd really appreciate it if you can use an example with numbers to help make explain more. Thank you!

Answer 1

Here I am Providing Practical Example for your question by which you can understand very easily. Before that you need to know following basic points 1. When Market Rate of Interest is Greater than Bond Rate. Bonds are Priced at Discount 2. When Market Rate of Interest is Lower than Bond Rate, Bonds are priced at Premium. 3. Under Effective Interest Method. Interest Expense-Bond Price x Market Rate 4. Interest Payment or Cash payment will be equals to Face Value of Bond x Coupon Rate or Bond Rate of Interest. Amortization of Discount or Premium is difference between the Issue price and Face value of the bond 5. Following Interest Calculations based on assumption that interest paid annually BONDS ISSUED AT DISCOUNT Face Value Coupon Rate Market Rate Issue Price 100,000.00 10% 15% 50,000.00 BONDS ISSUED AT PREMIUM Face Value Coupon Rate Market Rate ssue Price 100,000.00 10% 5% 150,000.00 $ 7,500.00 $ 10,000.00 7,500.00 10,000.00 ear eaf Cash Paid Discount Cash Paid Premium Amortization$ Amortization 2.500.00 2,500.00 ear Expense Cash Paid Discount $7.500.00 $ 10.000.00 7,500.00 10.000.00 Cash Paid Amortization 2,500.00 Amortization 2,500.00 Year 3 ear $7.500.00 $ 10.000.00 Expense Cash Paid Discount Amortization2.500.00 7,500.00 10.000.00 Cash Paid Premium Amortization 2.500.00 SO BASED ON ABOVE COMPARISION, OPTION B IS CORRECT