COMMERCE 1AA3 Lecture Notes - Lecture 31: Effective Interest Rate, Market Rate, Interest Expense
23 Nov 2016
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When a bond is sold below face value, it is a discount. When a bond is sold above face value, it is sold at a premium. The contract rate is a fixed rate attached to the bond. The bond sells at a premium or discount because the market rate is different than the contract. Carrying value will be equal to the face value at the end of the bond"s life. Market rate and the contract rate are the same. Interest expense is driven by or a function of market rate while interest payments are a function of the contract rate. The difference between interest expense and interest payment comes from amortizing the discount. Use either the straight-line method or the effective interest rate method. Interest payment will be the face value x contract rate /the number of times paid in a year. Interest expense = interest payment + discount amortization: effective interest rate method.
