bond and interest interest, therefore, understand

sweetgirl

sorry i am bombarding the board with silly questions, please bear with me for a moment.

a company issues a bond. then the interest increases, what the impact on Debt-to-equity ratio

A. An increase
B. A decrease
C. No change

The correct answer is B decrease D/E ratio as an increase in interest rate reduces the cost/price of the bond, therefore reducing the debt without changing the equity

What i dont understand here is that a bond is a-held-to-maturity item. so its not marked to market and its change in value should not be reflected on the income statement. the amount of debt should be fixed at its historical cost. is this correct?



Edited 1 time(s). Last edit at Monday, April 19, 2010 at 12:45AM by lzen5.

joemoran

First of all B is only the correct answer if they are asking for the 'true economic' effect on the D-E ratio. A change in market interest rates does not change the book value of the liability reported on the company's financial statements, and therefore does not change the company's reported D-E ratio.

To answer your question, you're confusing a financing liability (when a company issues a bond) with a financial asset (when a company owns a bond and classifies it as HTM).

You have be very careful when reading questions my man. Good luck!