[wishiwasaCPA]

I have a conceptual question about bonds:

Using Becker CPA, chapter 5 the lecturer (Tim) says that bonds issued at a premium are so great and blah blah. I don’t understand why a bond issued at a premium is so attractive. I want to make sure I get the concept of bonds down, I get the JEs, I get the amortization tables, I know how to compute the whole thing. However I don’t understand why a premium is considered better than a discount for the investor So if the borrower issues a bond at a discount, doesn’t the investor get more revenue than they would at a premium?

Example:

Investor (at a discount) when interest pmt is received:

DR: Cash $50,000

DR: Investment in Bonds $5,585

CR: Bond Interest Revenue: $55,585

Example:

Investor (at a premium) when interest pmt is received:

DR: Cash $50,000

CR: Investment in Bonds $7,026

CR: Bond Interest Revenue: $43,974

So why would an investor “bid” as they say, for a bond being issued at a premium? It seems like the investor would have a larger outflow of cash and a lower amount revenue earned. Seems like a discount gets you more revenue and you pay out less cash to the borrower.

[Anonymous]

Bonds issued at a premium typically have a higher interest rate so they have a greater return without any additional risk.

[M.O.D.]

The example in Becker is not accurate. The investor would receive a higher cash payment for a premium bond and a lower payment for a discounted bond. After the premium/discount is amortized the interest revenue would be equal.

The value is a matter of perception. Ultimately the upfront premium is converted to a smaller revenue and the upfront discount is converted to a larger revenue, which are equal.

This is the reason why he would bid higher than the face value of the bond: a higher interest rate payment than the market.

And vice versa, he would bid lower than the face value if the bond's interest rate pays lower than the market.

But finance theory (and accounting) says that ultimately, the payoff equals the market rate.

Tim Becker needs to study up on finance.

BA Mathematics, UC Berkeley
Certificates in CPA and EA preparation, College of San Mateo
CMA I 420, II 470
FAR 91, AUD Feb 2015 (Gleim self-study)

[Anonymous]

did you read this? https://bonds.about.com/od/bonds101/a/Premium-Bonds-And-Discount-Bonds-Definition-And-Explanation.htm

1. A higher coupon, which puts more money in the investor’s pocket.

2. The ability to capitalize on rising rates: since premium bonds offer higher income, this extra cash can be put to work at the higher prevailing rates.

3. Premium bonds are typically less sensitive to fluctuations in prevailing interest rates than similar discount bonds.

none of these except maybe #1 make sense to me though

[M.O.D.]

“There is therefore no advantage to buying a bond at a discount, or even a bond trading at par, versus one trading at a premium. Like anything in life, you get what you pay for – and no, there are no free lunches.”

Although you get more money in the form of interest (coupons), you had to pay that out in the form of a premium when you bought it.

Paying a bond premium is similar to buying a more expensive car which requires less maintenance over its lifetime.

Getting a bond discount is like buying a cheap car which requires more maintenance.

Over the lifetime the amounts are equal.

BA Mathematics, UC Berkeley
Certificates in CPA and EA preparation, College of San Mateo
CMA I 420, II 470
FAR 91, AUD Feb 2015 (Gleim self-study)

[Author]

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