Question

An individual purchased a taxable corporate bond at a premium. The bond has a remaining ten year maturity period. For federal income tax purposes, amortization of the premium:________

Answer 1

Available Options Are:

A. Increases investment interest expense

B. Is required

C. Reduces interest income

D. Increases interest income

E. Increases the basis of the bond

Answer:

Option C. Reduces Interest Income

Explanation:

The reason is that when we amortize the premium the carrying value of the bond decreases which decreases the principal amount and thus the interest calculated will also be decreased. The decrease in principal amount is because of the difference between the coupon rate of the bond and the firm's required rate of return.

Hence the amortization of the premium reduces the interest income.