Can someone help explain the concept of bond amortized discount? For example, if you have a bond that was issued at 96209 to yield 10%, and FV of the bond at the end of year 1 is 98,500, how does the $621 of amortized discount factor into how you calculate the balance sheet value of bonds?
Hi buddy,
This example seems very familiar. Anyway, let me try help:-
- YTM = Coupon => par bond
- YTM > Coupon => discount bond
- YTM < Coupon => premium bond
Using your example,the bond has par value of 100,000 has YTM of 10% and coupon of 9% is being issued at 96,209.
Okay, the above is a discount bond as it fit item 2 above where YTM > Coupon.
Next, we can tell ourselves that:-
- you will expect the value of the bond to move towards its par of 100,000 when it reaches the bond’s maturity
To calculate the interest expense at Year 1, we will use the effective interest rate method which is to mutiply the YTM of the bond (@ issuance) with the beginning value of the bond which is 96,209 in this case. This give us:
10% of 96,209 = 9,620.9
Now for the coupon, remember that it is computed by mutiplying the coupon rate by the face value of the bond:
9% of 100,000 = 9,000
We know that YTM is greater than Coupon Rate, and the difference between them is the amortization discount which is 9,620.9 - 9,000 = 620.9