Question: Although zero-coupon bonds are popular, notes and most bonds actually do pay a stated rate of cash

interest, one that is specified in the contract. If the buyer and the seller negotiate an effective rate of interest that

is the same as this stated rate, an amount equal to face value is paid for the bond. If the stated interest to be paid

is 7 percent each year and a negotiated annual rate of 7 percent is accepted by the parties, the bond is issued for

face value. No discount or premium results; the debtor and creditor are satisfied with the interest being paid. The

effective rate method is not needed because the cash interest and the effective interest are the same—7 percent is

paid and recognized as interest.

However, the negotiated rate often differs from the cash rate stated in a bond contract. Market interest rate

conditions change quickly. The interest that creditors demand will often shift between the printing of the indenture

and the actual issuance day. Or the financial reputation of the company might vary during this time. Information

travels so quickly in this technology age that news about companies—both good and bad—spreads rapidly

throughout the business community.

To illustrate, assume that Smith Corporation decides to issue $1 million in bonds to the public on January 1, Year

One. These bonds come due in four years. In the interim, interest at a stated cash rate of 5 percent will be paid

each year starting on December 31, Year One. These are term bonds because interest is conveyed periodically by

the debtor but the entire face value is not due until the end of the term.

No investors can be found who want to purchase Smith Corporation bonds with only a 5 percent annual return.

Therefore, in setting an issuance price, annual interest of 6 percent is negotiated. Possibly, interest offered by

other similar companies is 6 percent so that Smith had to match this rate to entice investors to buy its bonds.

Or some event has taken place recently that makes Smith seem slightly more risky causing potential creditors to

demand a higher rate of return. A list of market conditions that can impact the price of a bond would be almost

unlimited. How is the price of a bond calculated when the stated cash rate is different from the effective rate that

is negotiated by the two parties involved?

Answer: The pricing of a bond always begins by identifying the cash flows established by the contract. These

amounts are set and not affected by the eventual sales price. The debtor is legally obligated to make these

payments regardless of whether the bond is sold for $1 or $10 million.

Here, Smith Corporation must pay $50,000 per year in interest ($1 million × 5 percent) for four years and then the

$1 million face value:

Cash Flows in Bond Contract

$50,000 annually for four years

$1,000,000 in four years

After the cash flows are identified, the present value of each is calculated at the negotiated rate. These present

values are then summed to get the price to be paid for the bond. The $50,000 interest payments form an annuity

since equal amounts are paid at equal time intervals. Because this interest is paid at the end of each period starting

on December 31, Year One, these payments constitute an ordinary annuity1. As determined by table, formula, or

Excel spreadsheet, the present value of an ordinary annuity of $1 at an effective annual interest rate of 6 percent

over four years is $3.465112. Thus, the present value of the four interest payments is $50,000 times $3.46511 or

$173,256 (rounded). Note that the present value computation requires the multiplication of one annuity payment

($50,000) rather than the total of the interest payments ($200,000).

Present Value of an Ordinary Annuity of $1Present Value of an Ordinary Annuity of $1

The second part of the cash flows promised by this bond is a single payment of $1 million in four years. The

present value of $1 in four years at a 6 percent annual rate is $0.79209 so the present value of the entire $1 million

is $792,090.

Academic Heros
Calculate your paper price
Pages (550 words)
Approximate price: -

Why Work with Us

Top Quality and Well-Researched Papers

Our writers are encouraged to read and research widely to have rich information before writing clients’ papers. Therefore, be it high school or PhD level paper, it will always be a well-researched work handled by experts.

Professional and Experienced Academic Writers

For one to become part of our team, thorough interview and vetting is undertaken to make sure their academic level and experience are beyond reproach, hence enabling us give our clients top quality work.

Free Unlimited Revisions

Once you have received your paper and feel that some issues have been missed, just request for revision and it will be done. In addition, you can present your work to the tutor and he/she asks for improvement/changes, we are always ready to assist.

Prompt Delivery and 100% Money-Back-Guarantee

All our papers are sent to the clients before the deadline to allow them time to review the work before presenting to the tutor. If for some reason we feel our writers cannot meet the deadline, we will contact you to ask for more time. If this is not possible, then the paid amount will be refunded.

Original & Confidential

Our writers have been trained to ensure work produced is free of plagiarism. Software to check originality are also applied. Our clients’ information is highly guarded from third parties to ensure confidentiality is maintained.

24/7 Customer Support

Our support team is available 24 hours, 7 days a week. You can reach the team via live chat, email or phone call. You can always get in touch whenever you need any assistance.

Try it now!

Calculate the price of your order

Total price:

How it works?

Follow these simple steps to get your paper done

Place your order

Fill in the order form and provide all details of your assignment.

Proceed with the payment

Choose the payment system that suits you most.

Receive the final file

Once your paper is ready, we will email it to you.

Our Services

You have had a hectic day, and still need to complete your assignment, yet it is late at night. No need to panic. Place your order with us, retire to bed, and once you wake up, the paper will be ready.


Essay Writing Service

It does not matter the urgency of your paper, or the academic level, our team is ready to help you 24/7. Just contact us and all your academic needs will be sorted.


Admission Essays & Business Writing Help

A student is often required to write an admission letter requesting to be admitted in a certain institution. For you to be gain that admission in your dream institution, you must write a convincing letter. You can depend on our team for the best admission letters.


Editing Support

Academic writing is not just about getting information and throwing it all over. Our team will ensure you have a polished paper that is coherent and has a good flow of information. We also ensure the paper follows the correct formatting styles like APA, Harvard, MLA, Chicago/Turabian.


Revision Support

If our writers write a paper but you are not satisfied in one way or another, you can always ask for revision. This is totally free. Our writers and editors will revise your paper untill you are be totally satisfied. We as well offer revision for papers not done by our writers at a small fee.