Which of the following statements are correct?
A. If discount rate > coupon rate, then present value of a bond > face value
B. An annuity in which the periodic payment begins on a fixed date and continues forever is called perpetuity
C. The issuer of bond pays interest at fixed interval at fixed rate of interest to investor is called coupon payment
D. A sinking fund is a fixed payment made by a borrower to a lender at a specific date every month to clear off the loan
E. The issuer of bond repays the principal i.e. face value of the bond to the investor at a later date termed as maturity date
Choose the correct answer from the options given below:
Answer & explanation
Correct answer: option 3
The correct answer is Option (3) → B, C, E only
The present value of a bond is the coupon payments and the face value discounted at the market (discount) rate. A higher discount rate lowers the present value.
So a bond sells below face value when the discount rate exceeds the coupon rate, a perpetuity runs forever, coupons are the periodic interest, the face value is repaid on the maturity date, and a sinking fund is money set aside by the borrower, not paid to the lender.
Checking the statements
(A) If discount rate > coupon rate, then present value of a bond > face value — Incorrect. The present value is then less than the face value (a discount bond).
(B) An annuity in which the periodic payment begins on a fixed date and continues forever is called perpetuity — Correct. This is the definition of a perpetuity.
(C) The issuer of bond pays interest at fixed interval at fixed rate of interest to investor is called coupon payment — Correct. This is the definition of the coupon payment.
(D) A sinking fund is a fixed payment made by a borrower to a lender at a specific date every month to clear off the loan — Incorrect. That is an EMI; a sinking fund is accumulated by regular deposits to meet a future liability.
(E) The issuer of bond repays the principal i.e. face value of the bond to the investor at a later date termed as maturity date — Correct. This is the definition of the maturity date.