Module 28.1 & 28.2: Bond Issuance & Discount & Premium Bonds Flashcards
What is the effective rate of interest of a bond?
interest rate that equates the present value of the future cash flows of the bond and the issue price.
What is the liability of a bond equal to on the balance sheet?
equal to the present value of its remaining cash flows, discounted at the market rate of interest at issuance.
At issuance, explain why the market rate of interest may be equal to, less than, or greater than the coupon rate?
When the market rate is equal to the coupon rate, the bond is a par bond (priced at face value)
When the market rate is greater than the coupon rate, the bond is a discount bond (priced below par)
When the market rate is less than the coupon rate, the bond is a premium bond (priced above par)
Explain the effects to the three financial statements when a bond is issued at par?
Balance sheet - assets & liabilities increase by bond proceeds (face value). Book value of the bond will not change over time.
Income statement - interest expense equal to the coupon payment
Cash Flow statement - issue proceeds will be inflow of financing activities, interest expense payments are CFOA or CFFA (IFRS only).
Are the proceeds from a discount bond higher or lower than the par value of the bond?
lower, and vice versa for premium bonds.
What will the book value of the bond liability equal at any point in time?
at any point in time, a bond liability will equal the present value of the remaining future cash flows discounted at the bond’s yield at issuance.
For bonds issued at premium or discount, are interest expense rate and coupon rate the same? If no, why not?
they are not equal. Interest expense includes amortization of any discount or premium.
What is the effective rate method of amortizing a discount or premium bond? Is it required under IFRS and GAAP?
effective interest rate method - interest expense is equal to the book value of the bond liability at the beginning of the period, multiplied by the bonds yield at issuance.
Required under IFRS, under US GAAP, effective interest rate is preferred but straight line method is also allowed.
How do you calculate the beginning book value of a bond and then the ending book value in subsequent periods?
Beginning book value is the NPV of the bond using the calculator and market rate of interest as “I”.
Subsequent periods can be calculated by multiplying the beginning book value by the interest expense, adding that to beginning book value, and subtracting the coupon.
Explain how a zero coupon bond works and recorded on financial statements?
heavier discount, beginning book value is the NPV using market interest rate, and calculating ending book value until maturity.
