MythosHF

Interest expense is YTM times the carrying value of the bond while the cash interest cost is simply the actual coupon payments. Interest expense is an accounting figure (income statement) designed to estimate the cost of borrowing the market price amount at the YTM rate. A premium bond with the same principal value and with a higher coupon payment may have a higher interest expense, but this is the fault of the question for not specifying two key points: what feature of the bond is actually changing to produce a premium or discount; are coupon rates and maturities both dynamic?

It is possible that the coupon rate could remain the same while a changing maturity schedule could induce a premium or discount, but then the net interest expense differential would be a wash. If the maturity is assumed to remain the same, then coupon rates must be changing and would necessarily cause a higher interest expense. The question states that “market yield” remains static and I’ve never seen that term define a coupon rate, so I’m assuming this is either current yield or YTM and both terms indicate a changing coupon rate given the choice of a variable issue price.

Please correct me if I’m wrong… the wording of this question is a mind f*** as it seems to go either way.