Question about bond interest income income

tango_gs

Just want to make sure I understand the concept:

Let's suppose a bond is issued at par with a coupon of 5%. Face value is $1,000 and coupon is annual. The coupon payment won't change as that will always be $50. However the yield ($50/face value*100%) WILL as the value of the bond moves up and down in the market. So, you're still getting $50 of interest income it's just that the coupon may be plus/minus an amort. premium or discount and will sum up to $50. Right?

chandsingh

bonds are held to maturity, at historical cost. if you buy the bond above the par value, you amortize that premium over to maturity. your interest income is the coupon + the amortized premium.

the value of the bond based on yield is not a factor until the bond is sold.

DSquaredSlim

Suppose you bought a $1000 Face value bond which had a 5% coupon paid annually for a price of $950.
Further, suppose that the interest rate in the market for a bond of this type with similar risk is 6%.

In other words, you bought the bond at a discount. Because you bought the bond for $950 while the face value is $1000. If you held the bond until it matures, you will get $1,000.
The discount bond you bought will issue a coupon of $50 annually because the coupon is paid at 5%. Because the bond is paying only 5% when the market interest rate is 6%, the bond is available for a discount of $50 (1000 minus 950)

Also, upon purchase, the bond will be recorded in the Balance sheet at $950.
Cash reduced by 950 and securities up by 950 in your balance sheet.
Every year the bond's value will steadily increase to $1,000 in your balance sheet. For example, if the bond has 5 years to maturity, the value of the bond in your balance sheet during the second year will be equal to 950 + amortization of discount during the first year. The bond will be valued at $957 in the balance sheet in the second year, because the amortized amount is $7.
The amortized amount can be calculated as follows.
The total interest income recorded in the Income statement in the first year will be $57 - $950 * 0.06 = $57. (6% was the market interest at the time of issuance).
Out of the $57, $50 is coupon interest (actual cash received) and then $7 is the amortization of the bond towards par of $1000.

bdavi77962

I don't know for what stupid reason I thought the amortization would appear as a separate entry on the Income Statement. You know the concept, you know how to work the exact numbers, but you are not clear on an irrelevant accounting standard that fatefull morning.

-1

random_walker47

cruzjuan Wrote:
-------------------------------------------------------
> I don't know for what stupid reason I thought the
> amortization would appear as a separate entry on
> the Income Statement. You know the concept, you
> know how to work the exact numbers, but you are
> not clear on an irrelevant accounting standard
> that fatefull morning.
>
> -1


-2

liquidity

ZeroBonus Wrote:
-------------------------------------------------------
> so what's the process for a bond bought at a
> premium?
>
> interest income = original P * original interest
> rate?
>
> or do we add the amortization premium and get back
> to 2500?

original P * original interest is the way to calculate total interest expense
which will equal to coupon +/- discount/premium amortization

iteracom

ZeroBonus Wrote:
-------------------------------------------------------
> so what's the process for a bond bought at a
> premium?
>
> interest income = original P * original interest
> rate?
>
> or do we add the amortization premium and get back
> to 2500?

I am not recalling any 2500 number that you are talking about.

But extending my earlier example above, if the bond is being sold at a premium, the coupon of 5% is above the market interest of say 4% at the time the bond was purchased.

Again, as mentioned by jps1, the interest income for the first year will be 1050 * 0.04 = $42.
So, coupon of $50 minus $8 amortization of premium = $42 is what is recorded in the income statement for year 1.
The bond's carrying value in the balance sheet at the end of the first year is $1,050 minus $8 amortization = $1,042.

Best of luck to you all in your forthcoming exams.

madaochenggong

For a good discussion and example, see Page 70 of Schweser's Financial Reporting and Analysis book 2.

Best of luck to you all in your forthcoming exams.

Kapie

psriniva Wrote:
-------------------------------------------------------
> For a good discussion and example, see Page 70 of
> Schweser's Financial Reporting and Analysis book
> 2.


I did but that only talks about a bond bought at a discount. Regardless... based on the example u outlined above the interest income is definitely not Par Value x Coupon so 2,500 is wrong. Fk me

5566

If the bond was bought at a premium then the actual reported income would be smaller than the face par yield.