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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 unamortized discount on the date when the bonds are issued?
A)
$4,493.
B)
$499.
C)
$1,748.



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).


What is the unamortized discount at the end of the first year?
A)
$3,495.
B)
$1,209.
C)
$538.



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.

TOP

Interest expense is reported on the income statement as a function of:
A)
the coupon payment.
B)
the market rate.
C)
the unamortized bond discount.



Interest expense is always equal to the book value of the bond at the beginning of the period multiplied by the market rate at issuance.

TOP

On December 31, 2004, Newberg, Inc. issued 5,000 $1,000 face value seven percent bonds to yield six percent. The bonds pay interest semi-annually and are due December 31, 2011. On its December 31, 2005, income statement, Newburg should report interest expense of:
A)
$316,448.
B)
$300,000.
C)
$350,000.



Newberg, upon issuance of the bonds, recorded bonds payable of (N = (2 × 7) = 14, PMT = $175,000, I/Y = (6/2) = 3, FV = $5,000,000) $5,282,402. Interest paid June 30, 2005, was ($5,282,402 × (0.06 / 2) =) $158,472. The coupon payment was $175,000, reducing bonds payable to ($5,282,402 – ($175,000 - $158,472) =) $5,265,874. Interest paid December 31, 2005, was ($5,265,874 × (0.06 / 2) =) $157,976. Total interest paid in 2005 was ($158,472 + $157,976 =) $316,448.

TOP

Assume a city issues a $5 million bond to build a new arena. The bond pays 8 percent semiannual interest and will mature in 10 years. Current interest rates are 9%. Interest expense in the second semiannual period is closest to:
A)
$106,550.
B)
$80,000.
C)
$210,830.



Step 1: Compute the present value of the bond: Since the current interest rate is above the coupon rate the bond will be issued at a discount.
FV = $5,000,000; N = 20; PMT = (0.04)(5 million) = $200,000; I/Y = 4.5; CPT → PV = -$4,674,802
Step 2: Compute the interest expense at the end of the first period.
= (0.045)(4,674,802) = $210,366
Step 3: Compute the interest expense at the end of the second period.
= (new balance sheet liability)(current interest rate)
= $4,674,802 + $10,366 = $4,685,168 new balance sheet liability
(0.045)(4,685,168) = $210,833

TOP

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 the bond's market value be one year from now and what is the total interest expense over the life of the bond?
Value in 1-YearTotal Interest Expense
A)
10,181,495 2,962,107
B)
11,099,495 2,437,893
C)
10,181,495   2,437,893



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:
  • 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.
  • 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)(450,000) + 10,000,000] – 10,262,107 = 2,437,893

TOP

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%?
A)
929.
B)
923.
C)
935.



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)(0.08)]/2 = 40 I/Y = 5 N = 10 Compute PV = -923
Liability for the second period = 923 + [(0.05)(923) – 40] = 923 + 6 = 929
Liability for the third period = 929 + [(0.05)(929) – 40] = 929 + 6 = 935

TOP

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)
zero in all years.
B)
-$68,587 in 20X3 and -$74,074 in 20X4.
C)
-$142,661 in 20X4.



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

TOP

For a given par value, which of the following debt issues will have the highest cash flows from financing?
A)
Bonds issued at premium.
B)
Zero-coupon bond.
C)
Bonds issued at discount.



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

TOP

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).



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.

TOP

Which of the following statements is least accurate? When a bond is issued at a discount:
A)
cash flows from financing will be increased by the par value of the bond issue.
B)
the interest expense will be equal to the coupon payment plus the amortization of the discount.
C)
the interest expense will increase over time.



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

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