The balance sheet of Kmart Corporation as ofJanuary 25, 1995 included a long-term debt with a principal amount of $100 million. The annual interest rate on the debt was 12.5%, and the principal amount was due in ten years (2005). The $100 million amount on the balance sheet was equal to the present value of the debt’s future cash payments, discounted at 12.5%. This debt was in the form of bonds that were traded freely on the open bond market, and the 1995 annual report noted that the fair market value (January 25, 1995 market price) of the bonds was somewhat greater than the $100 million disclosed on the balance sheet. REQUIRED:

a. Explain how the market price of the bonds on the open market could be greater than the $100 million disclosed on Kmart’s balance sheet. (Hint: The price an investor is willing to pay for a bond is equal to the present value of the bond’s future cash flows, discounted at the current market interest rate.)

b. Provide a plausible explanation if the market price of the bonds was less than the $ 100 mil¬ lion disclosed on Kmart’s balance sheet.