Lesson 20

Question 1

In practice, what defines a long term liability?

Answer 1

If it does not meet the definition of a current liability, it must be long term

Question 2

Define long term debt

Answer 2

obligations to pay toward that is longer than a year

Question 3

A bond arises from a contract known as _______

Answer 3

A bond indenture

Question 4

A bond represents a promise to pay ________ (2 things)

Answer 4

1. a sum of money at a designated maturity date
2. periodic interest a specified rate on the maturity amount (face value)

Question 5

What is the main purpose of bonds?

Answer 5

It is to borrow for the long term when the amount of capital needed to too large for one lender to supply.

Question 6

What are common types of bonds?

Answer 6

1. Secured and Unsecured
2. Term, Serial, and Callable
3. Convertible, Commodity-backed, and Deep-discount
4. Registered and Bearer
5. Income and Revenue

Question 7

Secured Bonds are:

Answer 7

backed by a pledge of some sort of collateral. Example is mortgage bonds secured by a claim on real estate.

Question 8

Term bonds are:

Answer 8

bonds issues that mature on a single date

Question 9

Serial Bonds are:

Answer 9

issues that mature in installments

Question 10

Callable Bonds are:

Answer 10

give the issuer the right to call and redeem the bonds prior to maturity

Question 11

Convertible bonds are:

Answer 11

if bonds are convertible into other securities of the corporation for a specified time after issuance

Question 12

Commodity-backed bonds are:

Answer 12

aka asset-linked bonds are redeemable in measures of a commodity (barrels of oil, tons of coal, etc)

Question 13

Deep-discount bonds are:

Answer 13

aka as zero-interest debenture bonds and they are sold at a discount that provides the buyer’s total interest payoff at maturity

Question 14

Registered bonds are:

Answer 14

bonds issued in the name of the owner and require surrender of the certificate and issuance of a new certificate to complete a sale.

Question 15

Bearer bonds are:

Answer 15

aka coupon bonds, they are not recorded in the name of the owner and may be transferred from one owner to another by mere delivery.

Question 16

Income Bonds are:

Answer 16

they pay no interest unless the issuing company is profitable

Question 17

Revenue bonds are:

Answer 17

the interest on them is paid from specified revenue sources

Question 18

The investment community values a bond at the _______.

Answer 18

The present value of its expected future cash flows.

Question 19

What does the present value of expected future cash flows consist of?

Answer 19

Interest and principal

Question 20

What does stated, coupon, or nominal rates mean?

Answer 20

The interest rate is written in the terms of the bond indenture and printed on the bond certificate.

Question 21

The state rate of interest is expressed as a percentage of the _______ of the bonds.

Answer 21

Face value

Question 22

Face value is also called what? (3 things)

Answer 22

Par value, principal amount, or maturity value

Question 23

The difference between the face value and the present value of the bonds determines that actual price that buyers pay for the bonds. The difference is either a ________ or __________.

Answer 23

Discount or premium

Question 24

Discount means:

Answer 24

if the bonds sell for less than face value

Question 25

premium means:

Answer 25

if the bonds sell for more then face value

Question 26

The rate of interest actually earned by the bondholders is called?

Answer 26

effective yield or market rate

Question 27

what is the preferred procedure for amortization of a discount or premium ?

Answer 27

effective interest method aka present value amortization

Question 28

How do companies determine the effective interest method

Answer 28

1. compute bond interest expense first by multiplying the carry value (book value) of the bonds at the beginning of the period by the effective interest rate
2. determine the bond discount or premium amortization next by comparing the bond interest expense with the interest to be paid

Question 29

Discount on bonds payable is _________ because it does not provide any future economic benefit.

Answer 29

not an asset.

Question 30

What is the interest rate written in the terms of the bond indenture known as?

Answer 30

Stated rate

The interest rate written in the terms of the bond indenture (and often printed on the bond certificate) is known as the stated, coupon, or nominal rate.

Question 31

For which type of bond does the issuer have the right to call and retire the bonds prior to maturity?

Answer 31

Callable bond

Callable bonds give the issuer the right to call and redeem the bonds prior to maturity.

Question 32

Pontchartrain Company issues $20,000,000, 7.8%, 20-year bonds to yield 8% on January 1, 2017. Interest is paid on June 30 and December 31. The proceeds from the bonds are $19,604,145. The company uses effective-interest amortization.

What is the total interest expense reported on the 2017 income statement?

Answer 32

$1,568,498

When a bond is purchased for less than the face value of the bond, the bond is “issued at a discount” of $395,855. The cash payment on the bond is $780,000 ($20,000,000 x 7.8% x 6/12). On 01/01/2017, the carrying amount of the bond is $19,604,145. Total interest expense on June 30, 2017 is $784,166 ($19,604,145 x 8% x 6/12). On June 30, the carrying value of the bond is increased (the discount is reduced) by $4,166 ($784,166 - $780,000) to $19,608,311 ($19,604,145 + $4,166). Total interest expense on December 31, 2017 is $784,332 ($19,608,311 x 8% x 6/12). Therefore, total interest expense for 2017 is $1,568,498 ($784,166 + $784,332).

Question 33

Which is the rate of interest actually earned by bondholders?

Answer 33

Effective rate

The coupon rate, nominal rate, or stated rate is the interest rate that is written in the terms of the bond indenture. However, bonds are sold and purchased at either a discount or premium. The interest rate actually earned by the bond holder is the effective interest rate.