Financing Liabilities and Bond Terminology

Question 1

Financing Liabilities

Answer 1

A bond is a contractual promise between a borrower (the bond issuer) and a lender (the bondholder) that obligates the bond issuer to make payments to the bondholder over the term of the bond. Typically, two types of payments are involved: Periodic interest payment (coupon payments), and repayment of principal at maturity (face value; maturity value; par value)

Question 2

Face Value; maturity value;par value

Answer 2

The amount of principal that will be paid to the bondholder at maturity. The FV is used to calc. the coupon payments

Question 3

Coupon Rate

Answer 3

The int. rate stated in the bond that is used to calc. the coupon payments

Question 4

Coupon Payment

Answer 4

The periodic interest payments to the bondholders and are calculated by multiplying the FV by the coupon rate

Question 5

Effective Rate of Interest

Answer 5

The interest rate that equates the PV of the future CF’s of the bond and the issue price. The effective rate is the market rate of interest required by bondholders and depends on the bonds risks(default, risk, liquidity), as well as the overall structure of interest rates and the timing of the bonds cash flows. Do not confuse the market rate of interest with the coupon rate. The coupon rate is typically fixed for the term of the bond The market rate of interest on a firms bonds, however, will likely change over the bonds life, which changes the bonds market value as well.

Question 6

Balance Sheet Liability

Answer 6

OF a bond is equal to the PV of its remaining CF’s (coupon payments at FV), discounted at the market rate of interest at issuance. At maturity, the liability will equal the FV of the bond.The BS liability is also known as the BV of CV of the bond.

Question 7

Interest Expense

Answer 7

The interest expense reported in the income statement is calculated by multiplying the BV of the bond liability at the beginning of the period by the market rate of interest of the bond when it was issued.

Question 8

At the date of issuance, the market rate of interest may be equal to, less than, or greater than the coupon rate

Answer 8

When the market rate is equal to the coupon rate, the bond is par bond (priced at FV)

When the market rate is > coupon rate, the bond is discount bond (priced below par)

When the market rate is < coupon rate, the bond is premium bond (priced above par)