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Reading 39: Analysis of Financing Liabilities - LOS b ~ Q

26.Using the effective interest method, the interest expense in year 3 and the total interest paid over the bond life are approximately:

 

Year 3 Interest Expense

Total Interest

 

A)                $0.635 million                          $3.17 million

B)                $0.560 million                          $3.17 million

C)                $0.560 million                          $2.80 million

D)                $0.635 million                          $2.80 million

 

27.When the market rate is greater than the coupon rate, the bond is called a:

A)   par bond.

B)   discount bond.

C)   premium bond.

D)   debenture bond.

 

28.A bond is issued with an 8 percent semiannual coupon rate, 5 years to maturity, and a par value of $1000. What is the liability at the beginning of the third period if market interest rates are 10 percent?

A)   929.

B)   935.

C)   923.

D)   1,000.

 

29.A bond is issued with the following data:

§ $10 million face value.

§ 9% coupon rate.

§ 8% market rate.

§ 3-year bond with semiannual payments.

Assuming market rates do not change, what will be the bond's market value be in one year from now and what is the total interest expense over the life of the bond?

Value in 1-Year

Total Interest Expense

 

A)  11,099,495       2,437,893

B)  10,181,495       2,437,893

C)  11,099,495       2,962,107

D)  10,181,495        2,962,107

 

30.Which of the following statements about bonds issued at a discount is FALSE?

A)   Cash flow from operations will be overstated and cash flow from financing will be understated.

B)   Interest expense will have an upward trend for each period.

C)   Interest expense will equal the cash paid plus the amortization of the discount.

D)   The original liability will be higher than the bond's par value.

答案和详解如下:

26.Using the effective interest method, the interest expense in year 3 and the total interest paid over the bond life are approximately:

 

Year 3 Interest Expense

Total Interest

 

A)                                        $0.635 million       $3.17 million

B)                                        $0.560 million       $3.17 million

C)                                        $0.560 million       $2.80 million

D)                                        $0.635 million       $2.80 million

The correct answer was A)

§ Interest expense in any given year is calculated by multiplying the market interest rate (at time of issuance) by the bond carrying value. For example, in year 1, interest expense = 9,625,989 * 0.065 = 625,689. Since the coupon payment = 10,000,000 * 0.056 = 560,000, the interest expense is “too high” by 65,689, and the carrying value of the bond is increased (through a decrease in the unamortized bond discount account) to $9,691,678. In year 2, using a similar calculation, the carrying value of the bond increases to $9,761,637. Thus, the interest expense in year 3 = 9,761,637 * 0.065 = 634,506, or approximately $0.635 million.
 

§ Total interest expense is equal to the amount paid by the issuer less the amount received from the bondholder.

Amount paid by issuer = Face value + total coupon payments
= 10,000,000 + (0.056 * 10,000,000 * 5) = 12,800,000
Total interest paid over the life = 12,800,000 – 9,625, 989 = 3,174,011, or approximately$3.2 million.

 

27.When the market rate is greater than the coupon rate, the bond is called a:

A)   par bond.

B)   discount bond.

C)   premium bond.

D)   debenture bond.

The correct answer was B)

When the market rate is greater than the coupon rate, the bond will sell at a discount as investors will only buy the bond at a price which is less than fair value due to the coupon being lower than the market rate.

 

28.A bond is issued with an 8 percent semiannual coupon rate, 5 years to maturity, and a par value of $1000. What is the liability at the beginning of the third period if market interest rates are 10 percent?

A)   929.

B)   935.

C)   923.

D)   1,000.

The correct answer was B)

Beginning liability of the third period = liability of the second period + difference in the cash payment and the interest expense for the third period.

Liability for the first period = present value of the bond present value of the bond is computed as follows: FV = 1000 PMT = [(1000)(.08)]/2 = 40 I/Y = 5 N = 10 Compute PV = -923

Liability for the second period = 923 + [(.05)(923) – 40] = 923 + 6 = 929

Liability for the third period = 929 + [(.05)(929) – 40] = 929 + 6 = 935

 

29.A bond is issued with the following data:

§ $10 million face value.

§ 9% coupon rate.

§ 8% market rate.

§ 3-year bond with semiannual payments.

Assuming market rates do not change, what will be the bond's market value be in one year from now and what is the total interest expense over the life of the bond?

Value in 1-Year

Total Interest Expense

 

A)  11,099,495       2,437,893

B)  10,181,495       2,437,893

C)  11,099,495       2,962,107

D)  10,181,495        2,962,107

The correct answer was B)

To determine the bond's market value one year from now: FV=10,000,000; N=4; I=4; PMT=450,000; CPT PV= $10,181,495

To determine the total interest expense:

1.   FV=10,000,000; N=6; I=4; PMT=450,000; CPT PV= $10,262,107 this is the price the purchaser of the bond will pay to the issuer of the bond. From the issuer's point of view this is the amount the issuer will receive from the bondholder.

2.   Total interest expense over the life of the bond is equal to the difference between the amount paid by the issuer and the amount received from the bondholder.

                [(6)(450000) + 10,000,000] – 10,262,107 = 2,437,893

 

30.Which of the following statements about bonds issued at a discount is FALSE?

A)   Cash flow from operations will be overstated and cash flow from financing will be understated.

B)   Interest expense will have an upward trend for each period.

C)   Interest expense will equal the cash paid plus the amortization of the discount.

D)   The original liability will be higher than the bond's par value.

The correct answer was D)

Bonds issued at a discount will have an original liability that is lower than the bond's par value.

 

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