When the Market Moves, Will You Be Ready - Essay Example

Bonds carrying premium are issued at a price above the face value of the bond whereas bonds issued at discount are normally below the face value of the bond.

There are various reasons as to why the bonds are normally issued at face value, at discount, or at a premium and this largely depends upon the different circumstances. If the overall reputation and creditworthiness of the firm are relatively good in the market and investors have relatively better expectations of the future performance of the firm then the firm may be able to sell its bonds at a premium. Selling on the premium may also be because of the fact that existing bond issues having similar risk characteristics may be offering lower interest rates therefore if the issuer is willing to offer a higher rate of return to the lenders than it may be possible that the bond will be issued at a premium.

Similarly, bonds may be offered at a discount because issuing firms may not enjoy the relatively better credit ratings in the industry and investors are not willing to put more money into the firm. Selling at discount can also be due to the fact that the overall yield offered by the bond may be significantly lower than the existing bonds of the same risk category thus investors, in order to get compensated for the opportunity forgone to earn higher interest demand from issuing firms to offer their bonds at discount. (Navarro, 2003)

Finally issuing bonds at face value indicates the indifference of the investors towards the company i.e. investors may not have relatively more trust in the future prospects of the company and maybe expect to earn a normal rate of returns on their investment. Selling at face value does not however mean that the firm is not doing well or maybe face difficulties in the future but in actuality, it indicates the ability of the firm to match its offerings according to the market expectations.

There are different reporting requirements for bonds issued at premium, discount, and face value. Bonds issued at face value are amortized usually through the straight-line method and the liability of the issuer gradually reduces. However, reporting mechanism of bonds issued at a premium is relatively more complex because it requires the amortization of premium over the maturity period of the bond also. Premium is separately recorded and booked at the time of issuing the bonds and is reported as a part of equity. Every year the premium is taken into income according to the straight-line amortization schedule. On the other hand, issuers have to expense out the amount of discount offered at the time of issue over the period of the bond, and the discount amount is taken as an expense and reported as an expense in the profit and loss statement of the issuing firm. (Marshall, McManus, & Viele, 2003)