You are studying with some classmates and are reviewing each other’s responses to the following questions:

“If a company issued bonds with a contract interest rate of 5% when the market was looking for a yield of 4%, would the bonds be issued at a premium or a discount? What rate would be used to determine the company’s interest expense on the bonds?”

Your classmate responds as follows:

“If the contract rate was 5% when the market was looking for a yield of 4%, then the bonds would be issued at a discount. The 1% difference between the two rates means that the purchasers of the bonds would be unwilling to pay their full face value. The interest expense on the bonds would be determined using the yield rate of 4%.”

Required

a. Identify the part(s) of your classmate’s answer that are correct.

b. Identify the part(s) of your classmate’s answer that are incorrect.