honeycfa

A company sells a long-term, zero-coupon bond. The company’s cash flow from operations in subsequent years, compared to what it would have been if the company had issued debt at par for the same proceeds, will be:

A) understated.

B) properly stated.

C) overstated.

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Cash flow from operations (CFO) is systematically “overstated” when a zero-coupon bond is issued because the interest on a zero-coupon bond never reduces operating cash flow. The amortization of the bond discount at maturity is charged to financing cash flow when, in fact, it should be charged against CFO. Thus, CFO will be overstated.

honeycfa

Nomad Company issued $1,000,000 face value 2-year zero coupon bonds on December 31, 20X2 to yield 8% interest. Bond proceeds were $857,339. In 20X3 Nomad recorded interest expense of $68,587. In 20X4 Nomad recorded interest expense of $74,074 and paid out $1,000,000 to redeem the bonds. Based on these transactions only, Nomad’s Statement of Cash Flows would show cash flow from operations (CFO) of:

A) -$68,587 in 20X3 and -$74,074 in 20X4.

B) zero in all years.

C) -$142,661 in 20X4.

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All of the cash flows for zero coupon bonds are included in cash flow from financing activities and none in cash flow from operations.

honeycfa

Which of the following statements regarding zero-coupon bonds is most accurate?

A) The interest expense in each period is found by applying the discount rate to the book value of debt at the end of the period.

B) A company should initially record zero-coupon bonds at their discounted present value.

C) Interest expense is a combination of operating and financing cash flows.

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The liability initially recorded for a zero-coupon bond is equal to the proceeds received, which is the present value of the principal repayment discounted at the company's normal borrowing rate. Interest expense is found by applying the discount rate to the book value of debt at the beginning of the period, and there is no cash outflow from operations for a zero coupon bond.

honeycfa

For a given par value, which of the following debt issues will have the highest cash flows from financing?

A) Zero-coupon bond.

B) Bonds issued at premium.

C) Bonds issued at discount.

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The bonds issued at premium will have the highest cash flows from financing.

honeycfa

A zero coupon bond, compared to a bond issued at par, will result in higher:

A) interest expense.

B) cash flows from financing (CFF).

C) cash flows from operations (CFO).

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The zero-coupon bond will have higher cash flows from operations, as the cash interest expense in this case is zero and no cash is paid until maturity. Candidates should remember that any bond issued at a discount will have more cash flow from operations and less cash flow from financing.

honeycfa

Which of the following statements is FALSE? When a bond is issued at a discount:

A) the interest expense will be equal to the coupon payment plus the amortization of the discount.

B) cash flows from financing will be increased by the par value of the bond issue.

C) the interest expense will increase over time.

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Upon issuance, cash flow from financing will be increased by the amount of the proceeds.

honeycfa

A $1,000 bond is issued with an 8% semiannual coupon rate and 5 years to maturity when market interest rates are 10%. What is the initial liability?

A) 923.

B) 855.

C) 1023.

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FV = 1000; PMT = 80/2; N = 5 × 2; I/Y = 10/2; solve for PV = 923.

honeycfa

A company issued a bond with a face value of $67,831, maturity of 4 years, and 7% coupon, while the market interest rates are 8%.

What is the unamortized discount when the bonds are issued?

A) $2,246.65.

B) $1,748.07.

C) $498.58.

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Coupon payment = ($67,831)(0.07) = $4,748.17.
Present value of bond: FV = $67,831, N = 4, I = 8, PMT = $4,748.17, CPT PV = $65,584.35.
Discount = $67,831 - $65,584.35 = $2,246.65.

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What is the unamortized discount at the end of the first year?

A) $1,209.61.

B) $1,748.07.

C) $538.46.

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Interest expense = ($65,584.35)(0.08) = $5,246.75.
Coupon payment = ($67,831)(0.07) = $4,748.17.
Change in discount = $5,246.75 - 4,748.17 = $498.58.
Discount at the end of the first year = $2,246.65 - 498.58 = $1,748.07.

honeycfa

A firm issues a $5 million zero coupon bond with a maturity of four years when market rates are 8%. Assuming semiannual compounding periods, the total interest on this bond is:

A) $1,346,549.

B) $1,200,000.

C) $1,600,000.

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The interest paid on the bond will be the difference between the future value of the bond of $5,000,000 and the proceeds of the bond when it was originally issued.

First find the present value of the bond found by N = 8; FV = 5,000,000; I = 4; PMT = 0; CPT → PV = ?3,653,451.  This is the amount of money the bond generated when it was originally issued.

Then take the difference between the $5,000,000 future price and the $3,653,451 from the proceeds  = $1,346,549 which is the interest paid on the bond.

honeycfa

A company issued an annual-pay bond with a face value of $135,662, maturity of 4 years, and 7% coupon, while the market interest rates are 8%.

What is the present value of the interest payments on the date when the bonds are issued?

A) $131,164.

B) $31,453.

C) $49,857.

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Present value of the interest payments on the date of issue is $31,453 = [I/Y = 8.00%; N = 4; PMT = $9,496.34 ($135,662 × 0.07); FV = $0; CPT → PV].

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What is the unamortized discount on the date when the bonds are issued?

A) $499.

B) $4,493.

C) $1,748.

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The unamortized discount rate at the time bonds are issued will be $4,493.

Face value of bonds = $135,662.
Proceeds from bond sale = $131,168.70 [I/Y = 8.00%; N = 4; PMT = $9,496.34 ($135,662 × 0.07 ); FV = $135,662; CPT → PV].
Unamortized discount = $4,493 = ($135,662 ? $131,169).

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What is the unamortized discount at the end of the first year?

A) $1,209.

B) $3,495.

C) $538.

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The unamortized discount will decrease by $998 at the end of first year and will be $3,495.

Interest expense = ($131,169)(0.08) = $10,493.52, or $10,494.
Coupon payment = ($135,662)(0.07) = $9,496.
Change in discount = ($10,494 ? $9,496) = $998.
Discount at the end of first year = $4,493 ? $998 = $3,495.