Principles of Accounting II - Spring 2013 OL4
Quiz #1 – Part 2
1. Bonds are frequently issued at amounts greater or less than face value. Describe how the market interest rate, relative to the contractual interest rate, affects the selling price of bonds. Also explain the rationale for requiring an investor to pay accrued interest when a bond is purchased between interest payment dates.

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The market interest rate is usually different from the contractual interest rate. With that being said bonds are frequently issued at an amount higher than face value or could also be issued at an amount lesser than face value. When the market has a higher interest rate than the contractual rate, investors find other investments to contribute to which consequently makes that bond in less demand. To ensure bonds are more attractive to investors the issue price is lowered and bonds are sold at a discounted rate. If the market interest rate is less than the contractual rate there is greater demand for the bond because the interest rate is then higher. In this instance, the issue price would be greater than face value and the bonds are issued at a premium rate. Investors are required to pay interest accrued as it allows the issuer of the bond to make the same payment of interest to all bondholders on the same interest payment date. If this were not completed, the bond issuer would have to then determine the payment of interest to each bondholder based on aspects like how long that bond has been outstanding. This in turn means the bond issuer doesn’t have to maintain any detailed records and can save costs such as