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S2000 - just saw you replied to my last question. Thank you SO MUCH. I’m going to print out your answer and review that next.
The below answer uses “amortization of the discount.” The wording on this question is not making sense, evne though it seems like a easy question. Can someone please try to help explain? Does the last sentence of the question not used (decline to 5.5%)?
The answer is: Barnes’ bond offering is issued at a discount (market rate > coupon rate). The amortization of the discount will be added to interest expense, thus making the reported expense greater than the $12 million coupon payment ($200 million × 6%).
The only thing that matters is that the bonds were issued at a discount; when that discount is amortized, it will increase the interest expense (above the amount of the coupon payments).
The fact that interest rates change later is irrelevant; the bonds were issued at a discount irrespective of what happens later.
Under effective yield method, interest expense = Carrying value * Yield at issue. For a discount bond while CV will be less than 100 (FV) the yield at issue will be higher than coupon, which would invariably lead to higher interest expense. Also please note that CV will increase for a discount bond (as say $97 moves towards $100) but yield at issue will remain same. This would also result in interest expense increasing for a discount bond as maturity nears