honeycfa

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

honeycfa

When the market rate is greater than the coupon rate, the bond is called a:

A) par bond.

B) premium bond.

C) discount 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.

honeycfa

At the date of issuance the market interest rate was above the coupon rate. Bonds of this nature would sell for:

A) discount.

B) par.

C) premium.

---

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

honeycfa

Interest expense is reported on the income statement as a function of:

A) the market rate.

B) the coupon payment.

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.

honeycfa

On December 31, 20X3 Okay Company issued 10,000 $1000 face value 10-year, 9% bonds to yield 7%. The bonds pay interest semi-annually. On its financial statements (prepared under U.S. GAAP) for the year ended December 31, 20X4, the effect of this bond on Okay's cash flow from operations is:

A) -$700,000.

B) -$755,735.

C) -$900,000.

---

The coupon payment is a cash outflow from operations. ($10,000,000 × 0.09) = $900,000.

honeycfa

A company issued an annual-pay bond with the following characteristics:

Face value	$67,831
Maturity	4 years
Coupon	7%
Market interest rates	8%

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

A) $49,857.

B) $65,582.

C) $15,726.

---

Present value of the interest payments on the date of issue is $15,726. I/Y = 8.00%; N = 4; PMT = $4,748.17 ($67,831 × 0.07 ); FV = $0; CPT → PV.

---

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

A) $15,729.

B) $1,748.

C) $2,249.

---

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) $1,209.

C) $1,750.

---

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)

honeycfa

Which of the following statements regarding the issuance of a discount bond is most accurate?

A) The cash from investing (CFI) is increased by the amount of the proceeds.

B) The cash from operations (CFO) is understated.

C) The cash from financing (CFF) is increased by the amount of the proceeds.

---

The cash from financing (CFF) is increased by the amount of the proceeds. The cash from operations (CFO) is overstated because it will not include the amortization of the discount, which increases interest expense. There is no effect on CFI.

honeycfa

Over time, the reported amount of the annual interest expense on a long-term bond issued at a discount will:

A) remain constant.

B) decrease.

C) increase.

---

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.

honeycfa

A long-term bond is sold at a discount. In subsequent years cash flow from operations will be:

A) overstated.

B) properly stated.

C) understated.

---

Cash interest is only part of the interest expense. The amortization of the bond discount at maturity is charged to financing cash flow when in fact it should be charged against cash flow from operations, so CFO will be overstated.

honeycfa

Which of the following statements regarding the issuance of bonds is most accurate? Compared to bonds issued at par, bonds issued at a:

A) discount will have overstated cash flows from operations (CFO).

B) premium will have overstated cash flows from operations (CFO).

C) discount will have overstated cash flows from financing (CFF).

---

Bonds issued at discount will have more cash flows from operations and less cash flows from financing. Thus, CFO is overstated and CFF is understated. Bonds issued at a premium will have overstated CFF and understated CFO.