Question

Your business associate mentions that she is considering investing in corporate bonds currently selling at a premium. She says that since the bonds are selling at a premium, they are highly valued, and her investment will yield more than the going rate of return for the risk involved. Reply with a memorandum to confirm or correct your associate’s interpretation of premium bonds.

Short answer

The Interpretation of our associates is not correct. It is necessary to consider many other factors before investing in premium bonds.

Step-by-step solution

Step 1:Meaning of Memorandum

A memorandum refers to ashort note that contains some information prepared for a person or a particular group of people for communication purposes

Preparation of memo

To: Associate

From: ABC

Subject: Interpretation of premium bonds

When the bonds are issued at a premium, you have to pay more cash for the securities than the bonds’ standard estimation or par value; similarly; the issuing company receives more cash by selling bonds at a premium than the amount that is required to pay to the bondholders at the maturity date.

However, the interest paid to the bondholders is determined as a rate of the standard worth or par value. It means the investment made by bondholders by purchasing bonds at a premium yield less than the contract interest rate. The market interest rate is less than the contract rate of interest in the case of premium bonds.

One should also focus on many other factors, like risk, interest rate, bond duration, etc., while investing in bonds.

Therefore, the associate’s interpretation is not correct. For investing in bonds, they should consider all the factors instead of one factor the bonds are selling at a premium.