[sharifah]

Billy and Co. is issuing a RM1,000 par value bond that pays 9% interest annually. Investors are expected to pay RM918 for the 10-year bond. Billy will have to pay RM33 per bond in flotation costs. What is the cost of debt if the firm tax rate is 34%?

[morgaine300]

It means that's the current selling price of the bonds. Bond values change because they have a fixed interest rate, but interest in the market changes all the time. So you're comparing the interest you're actually getting on the bond to what the current rate would be.

So let's say the current market rate on a similar bond was only 8%. That means this bond is worth more because it's paying at 9%. Or, what if the current market rate is 10%. This bond is then worth less cause it's now "only" paying 9%.

So if current rates were 10%, why would you want to pay the same amount for one only paying 9%? You wouldn't. But what if you could get it for cheaper? The 10% one is $1000, but you can get the 9% one at $950. You'll get less interest, but you'll get the full $1000 back when it comes due, so you get that extra $50 in there.

So that's a discounted price, because the market rate is higher than 9%.