Bonds & PV tables Flashcards
what is a term bond?
a bond that will pay the entire principal upon maturity at the end of the term
what is a serial bond?
a bond in which the principal matures in installments
what are debenture bonds
unsecured bonds that are not supported by any collateral
what is the stated, face, coupon, nominal rate?
rate that is printed on the bond, represents the amount of cash the investor will receive every payment.
what is the carrying amount of a bond?
the net amount at which the bond is being reported on the B/S and equals the face value of the bond plus the premium (when the bond was issued above face) or minus the discount (when the bond was issued below face value). it is also called the “book value” or “reported amount.” it will initially be the same as issue price but gradually approaches the face value as time passes since the premium or discount is amortized over the life of the bond.
what is the effective, yield or market rate (all mean the same)
the actual rate of interest the company is paying on the bond based on the issue price. the effective rate is often called the market rate of interest or yield.
what happens when a bond is issued at a premium?
the effective rate is lower than the stated rate, since cash interest and principal repayment are based on face value, but the company actually received more money than that
what happens when a bond is issued at a discount?
the effective rate of interest will be higher than the stated rate since the company must pay cash interest and principal based on a higher amount than the funds actually received upon issuance.
what are convertible bonds?
a bond that is convertible into common stock of the debtor at the bondholders option
what are callable bonds
a bond which the issuer has the right to redeem prior to is maturity date
what are bond covenants
restrictions that borrowers must often agree to
when will the effective interest method of bond amortization NOT be used?
when the company elects the Fair Value option for reporting financial assets and liabilities, in particular w/bonds (financial liabilities) are reported @ fair value at the end of each reporting period.
what is the journal entry when a bond is issued and the market & stated rate are the same?
bond is issued @ Par
debit- cash
credit- bonds payable
Interest payments
- debit: Interest expense (face amnt X stated rate)
- credit: cash (face amount X stated interest rate on bonds)
** for interest expense calculations; Cash is ALWAYS credited for the same amount each period and it is ALWAYS for the face amount X stated rate of interest
what is the journal entry when a bond is issued and the market is HIGHER THAN the stated rate?
the bond is issued at a discount so they will receive less cash.
@ issuance:
“debit” - cash (face amount less discount)
“debit” - discount on bond (amount at PV factor)
“credit”- bonds payable (face amount of bond)
recording of interest expense
debit-interest expense
credit- discount
credit -cash
Note the discount must be amortized over the life of the bond.
remember cash is always the face value X stated amount of interest on the bond
what is the journal entry when bonds are issued @ a premium?
debit-cash (face value + premium amount)
credit-premium (amount above face value)
credit-bonds payable (face amount of bond)
same rules apply as w/a bond discount. premium must be amortized over the life of the bond to bring the value down to the face amount
when amortizing a discount what happens to interest expense & the amortization amount of the discount?
Interest expense increases each year and the amortization amount increases each year.
when amortizing a premium what happens to interest expense & the amortization amount of the discount?
when amortizing a premium the interest expense decreases each year and the amortization premium increases each year.
what is the formula for calculating the discount or premium amortization over multiple years?
Year 1:
face amount of bond minus the discount (discount amount -face amount of bond) = the carrying value of the bond
Carrying value is then multiplied by the effective interest rate will equal the interest expense for that year.
interest expense is subtracted from the cash payment of interest which will always be the face of the bond multiplied by the stated interest rate on the bond multiplied by time.
the difference between the interest expense and the cash payment will be the amount of the amortization.
year 2:
the amortization amount is added to the carrying value if it is a discount on subtracted from the carrying value if it is a premium then the process is repeated
Note: the goal is to increase a discount to the face amount of the bond & decrease a premium to the face amount.
how do you calculate the present value of the proceeds
two amounts needed
- pv of the face of the bond (face X PV of a lump sum using the effective interest rate)
- pv of the interest as an annuity (face amount X stated interest rate X time = the interest expense. The interest expense amount is then multiplied by the PV of an ordinary annuity rate at the EFFECTIVE INTEREST RATE.
The sum of these two amounts represents the PV of the bonds
how is interest paid semi annually calculated?
- # of years multiplied by 2
- the interest rate divided by 2
what is compound interest
future values of interest - these look at cash flows and project them to some future date and the formula is as follows:
future value factor (the amount that you use to get the future value) is equal to 1 divided by the present value factor.
for example 10,000(future value factor) X 1/.8265 (1 divided by present value factor)
how do you convert from an annuity due (one due at the beginning of the period) to an ordinary annuity (one that is due at the end of the period)
-use the factor from one more period than you need then subtract 1 from that rate
how do you convert from an ordinary annuity (one that is due at the end of the period to an annuity due (one due at the beginning of the period)
-use the factor for one LESS period and ADD 1.0 to it.
what is the journal entry at the issuance of a bond?
debit- cash (face + accrued interest-bond issuance cost)
debit- bond issuance cost
discount- (plug)
credit- bonds payable
credit - accrued interest payable (face amount of bond X stated rate of interest X time since LAST interest amount was paid)
