The time value of money is a notion that shows that money is worth more now than it will be in the future. For example, an investor would prefer to get $100 now rather than $100 in a year. By obtaining $100 today, the investor can put it in a savings account and collect interest, resulting in a total of more than $100 in a year.
Taking the aforementioned concept further, zero-coupon bonds need an investor to be compensated with a higher future value if they purchase the bond today. Because the issuer must provide a return to the investor for purchasing the bond, a zero-coupon bond must trade at a discount.
Do zero-coupon bonds command a higher price?
What circumstances allow a zero-coupon bond to be sold at a premium? A zero-coupon bond, unlike a coupon bond, has no recurring cash flow and only receives one lump-sum payment of the face value at maturity. As a result, a zero-coupon bond will always be sold for less than its face value.
Do zero-coupon bonds trade for a higher price before they mature?
Because they are exposed to interest rate risk if investors sell them before maturity, zero-coupon bonds, like other bonds, incur various sorts of risk.
When is it possible to sell a zero-coupon bond at a discount?
Because the purchaser must keep the bond until maturity to make a profit, the market price of a zero coupon bond is usually lower than its par value. A bond is considered to sell at a discount if it sells for less than its face value.
Why are some bonds offered at a discount while others are sold at a premium?
As a result, when interest rates fall, bond prices rise as investors race to purchase older, higher-yielding bonds, which can then be sold at a premium. In contrast, as interest rates rise, new bonds are issued at higher rates, pushing bond yields higher. As a result, those bonds are sold at a discount.
When are premium bonds issued?
When a bond is issued at a premium, it signifies that the bond is sold for a price higher than its face value. This often signifies that the bond’s contract rate is more than the market rate. The difference between the bond’s face value and the sales price must be amortized during the bond’s term, much like a discount bond. Unlike a bond issued at a discount, however, the process of amortizing the premium reduces the bond’s interest expense recorded on the issuing company’s books. The issuing firm will still be responsible for paying the bondholder the promised interest payments.
What does it mean when a bond is trading at a discount?
A discount bond is a bond that is currently trading in the secondary market for less than its par value. When a bond’s coupon rate is lower than the current interest rate, it is said to be trading at a discount. Investors will pay less for a bond with a lower coupon rate than the current rates because the upfront discount compensates for the lower coupon rate.
What is the current yield on a bond that is trading at a discount?
The current yield is the same as the coupon rate when a bond is acquired at face value. Assume, however, that the bond was purchased at a lower price than its face value Rs 900. The current yield (Rs 60/Rs 900) is 6.6 percent. This is the total return an investor will receive if he or she holds the bond until it matures.
When premium bonds are issued, the quizlet?
When a firm issues a bond at a discount, the interest expense will be greater than the annual interest paid. When bonds are issued at a premium, the interest expense is less than the interest paid on the bonds.
What makes a coupon bond different from a zero-coupon bond?
The payment of interest, often known as coupons, distinguishes a normal bond from a zero-coupon bond. A standard bond pays interest to bondholders, whereas a zero-coupon bond does not pay interest to bondholders. Instead, when a zero-coupon bond matures, the holder receives the face value of the bond. Regular bonds, commonly known as coupon bonds, pay interest and repay the principle throughout the course of the bond’s existence.