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Financial Reporting and Analysis 【Reading 32】Sample

A company issued an annual-pay bond with the following characteristics:
Face value$67,831
Maturity4 years
Coupon7%
Market interest rates8%
What is the unamortized discount on the date when the bonds are issued?
A)
$2,249.
B)
$15,729.
C)
$1,748.



The unamortized discount at the time bonds are issued will be $2,249.
Face value of bonds = $67,831
Proceeds from bond sale = $65,582 [I/Y = 8.00%; N = 4; PMT = $4,748.17 ($67,831 × 0.07); FV = $67,831; CPT → PV]
Unamortized discount = $2,249 ($67,831 − $65,582)


What is the unamortized discount at the end of the first year?
A)
$538.
B)
$1,750.
C)
$1,209.



The unamortized discount will decrease by $499 at the end of first year and will be $1,750.
Interest expense = $5,247 ($65,582 × 0.08)
Coupon payment = $4,748 ($67,831 × 0.07)
Change in discount = $499 ($5,247 − $4,748)
Discount at the end of first year = $1,750 ($2,249 − $499)

Assuming all else equal, if the coupon rate offered on a bond is less than the corresponding market rate of interest, the bond will be issued at:
A)
a premium.
B)
a discount.
C)
par.



If the coupon rate is less than the market rate, the bond must be sold at a discount so the effective rate on the bond equals the market rate.

TOP

Proceeds from issuing a bond are recorded on the statement of cash flows as an inflow from:
A)
investing (CFI).
B)
financing (CFF).
C)
operations (CFO).



Cash from financing (CFF) is increased by the amount of the proceeds.

TOP

Over time, the reported amount of the annual interest expense on a long-term bond issued at a discount will:
A)
increase.
B)
remain constant.
C)
decrease.



A portion of the discount must be amortized to the interest expense each year. The amortized amount is debited to interest expense and credited to debt. So debt goes up. The interest expense is debt times the effective interest rate. Thus, interest expense will increase over time.

TOP

At the date of issuance the market interest rate was above the coupon rate. Bonds of this nature would sell for:
A)
par.
B)
discount.
C)
premium.



When the contract rate on a bond is lower than the market rate, a bond will sell for a discount.

TOP

A firm issues a $5 million zero coupon bond with a maturity of four years when market rates are 8%. Assume semi-annual compounding.
What is the firm's initial liability and the value of the liability in six months?
[td=1,1,100]Initial LiabilityLiability in 6 months
A)
$3,675,149$3,675,149
B)
$5,000,000$5,000,000
C)
$3,653,451$3,799,589



The initial liability is: N = 8, I/Y = 4%, PMT = 0, FV = $5,000,000, Compute PV = -$3,653,451.
The value of the liability 6 months is: [$3,653,451 + {0.04($3,653,451)}] = $3,799,589

TOP

When the market rate is greater than the coupon rate, the bond is called a:
A)
par bond.
B)
discount bond.
C)
premium bond.



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.

TOP

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)
Interest expense is a combination of operating and financing cash flows.
C)
A company should initially record zero-coupon bonds at their discounted present value.



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.

TOP

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)
855.
B)
1023.
C)
923.



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

TOP

A company issued a bond with a face value of $67,831, maturity of 4 years, and 7% annual-pay 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.



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.

TOP

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