CFA Practice Question

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CFA Practice Question

If a company issues debt at a premium, and it uses the effective interest method to account for interest and premium amortization, the debt's interest expense and its book value, respectively, will behave as follows over the term of the bond issue:

A. increase; decrease
B. decrease; decrease
C. decrease; increase
Correct Answer: B

Under the effective interest method, the interest expense is computed using the effective rate times the book value of the bond. The amortization will decrease the premium, which will decrease the book value of the bond. The interest expense will also decrease, as it is based upon the decreasing book value of the bond.

User Contributed Comments 2

User Comment
achu Remember: interest expense calc'd using ieff * Bond BV. Thus they both change in SAME direction.
khalifa92 value reduced til par.
interest exp reduced to offset the premium received.
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