Question

Sawada Insurance Ltd. issues bonds with a face value of $100 million that mature in 12 years. The bonds carry a 6% interest rate and are sold at 104.35 to yield 5.5%. They pay interest semi-annually.

(b)

Explain why the issuance price of the bonds is not the same as their face value.

Answer 1

Answer

• Bonds face value is $ 100 million.
• However it was issued at 104.35

This means that issue price = $ 100 x 104.35/100 = $ 104.35 millions.

• Hence, issue price is NOT SAME as the face value, as the Bonds are ISSUED AT PREMIUM.
• This is mainly because of Interest Rates.

You see, the interest rate that the Bond will be paying to its investors is 6%,

While the interest rates that the market pays is 5.5% only.

This means that the company issuing the Bond is paying more interest to investors who will invest in these bonds that what they would have earned had they invested in general market.

For this increased interest, the company has charged ‘PREMIUM’ on issue.

As a result the Issuance price of the Bonds is not the same as their face value.