Suppose a company issues bonds with par value of $1,000, a maturity of 5 years, and a coupon rate of 8% paid annually. The company decided to sell the bonds below par at $995. Although the bond is issued at less than par, it still provides the buyer with the same cash flow stream as if it were issued at par. The bondholder will receive $80 each year for the following 4 years and will receive $1,080 the fifth year if the bond is kept until maturity. Thus, the expected return is higher than the 8% coupon rate because when the bond is redeemed in 5 years, the holder will realise a capital gain of $45 ($1,000 less $955). It also means that the company is actually borrowing at a cost higher than the 8% coupon rate, and even higher than the current yield of 8,38% (the $80 coupon payment of the bond divided by its $955 price).
What is this expected return? Why the company issues its bonds at a discount? Why not issue them at par and thus borrow at the 8% coupon rate?