»Ê¹ÚÌåÓýapp

Borrowing at a discount or premium

Instead of paying interest to a lender, a company could negotiate to pay an additional amount on redemption. This is known as a premium. »Ê¹ÚÌåÓýapp company will need to negotiate the amount it will pay to reward the lender. If no interest is payable then the calculation of the amount to be paid at the end of the term of the debt might be based on the interest that the lender might have received if the loan had been at interest. »Ê¹ÚÌåÓýapp size of the premium would also reflect any risk that the sum borrowed will not be repaid.

Where the premium represents the lender’s reward for the loan of the money, it would typically fall be characterised as interest for tax purposes.

Example

In the example at CFM11090, the company wanted to borrow £10,000 at 10% per annum for 3 years. »Ê¹ÚÌåÓýapp compound interest on the borrowing was £13,310. »Ê¹ÚÌåÓýapp company might instead offer to repay £13,350 at the end of 3 years on borrowings of £10,000. »Ê¹ÚÌåÓýappre is a premium of £3,350.

Original issue discount

As an alternative the company could issue a bond, either with no interest return or at a less than market price. An investor would not be willing to pay the full principal amount to take up this issue, so the issue would have to be made at a discount to the redemption price.

As such, the reward to the lender would instead be a discount on issue. A similar calculation would be made as above but the documentation would show that the bond has a face value of say £13,350. »Ê¹ÚÌåÓýapp face value is the price on the bond, that is, it will promise to repay £13,350. »Ê¹ÚÌåÓýapp issue price, the amount the lender or subscriber pays to buy the bond from the issuing company, will be £10,000. »Ê¹ÚÌåÓýapp bond has then been issued at a discount of £3,350. »Ê¹ÚÌåÓýapp company has its £10,000 and the lender will get its reward, the £3,350, on redemption.

Sometimes the yield on a security on issue is fine-tuned by issue at a discount or premium. For instance a company might enter into a facility under which it could issue 5-year notes at rate of interest of 5%, at various dates, or even a single future date. »Ê¹ÚÌåÓýapp issue price would be adjusted down or up from the redemption price to reflect prevailing rates at the time of issue.