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Zero Coupon Bond

Is interest expense understated or overstated in this type of bond?

And can someone explain how int expense is handled for a zero coupon bond.

Thanks

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zero coupon bond sells at discount.
CFO = severly overstated
CFF = understated.

someone pls verify

There is no interest expense for Zero coupon bonds. That is why the CFO is overstated in the case of a Zero coupon bond.

Interest expense is more for a discount bond and low for a premium bond.

that’s correct.. I got that part of the Q correct.. But I am just not sure how it all relates to int expense.

Int expense = coupon + discount amortization
Int expense = coupon - premium amortization

There is interest expense that’s what brings the liability upto par. But i’m not sure if it’s overstated or understated?

CFO will be overstated because the interest expense flowing through it is understated (does not exist).

mambo, man this is not the time to confuse yourself. take alook in the book. if i am wrong let me know, don’t put questions stating uncertainties.

mcf Wrote:
——————————————————-
> CFO will be overstated because the interest
> expense flowing through it is understated (does
> not exist).

That’s what I was looking for.. makes perfect sense, thanks

remember interest expense on zero coupon bonds = amortization = NON CASH ITEM. therefore CFO is overstated

you also issues zero coupon bond at discount (which is redeemable at par at maturity). Hence CFF is understated.

Here’s the Q,
At the beginning of the year, two companies issued debt with the same market rate, maturity date, and total face value. One company issued coupon-bearing bonds at par and the other company issued zero-coupon bonds. All other factors being equal for that year, compared with the company that issued par bonds, the company that issued zero-coupon debt will most likely overstate:

A. cash flow from operations but not interest expense.
B. interest expense but not cash flow from operations.
C. both cash flow from operations and interest expense.
D. neither cash flow from operations nor interest expense.

A

there is no interest expense for a zero coupon bond, so CFO is over stated.

desmoquattro

I would say A? interest expense would still be the same, but it is all amortization, but it is not a cash amount.

Yep. A

yep A.

there is no interest expense for zeros.

actually both CFO and interest expense are overstated.

Although no coupon payment is made, the discount is amortized over the term of bond and interest expense is recognized in the income statement….

so interest has to be recognized, it’s the reason the CFO is overstated because only the coupon payment is reported in CFO (which is zero even though there IS an interest expense equal to the bond’s amortization).

desmoquattro

I have to write this concept out every time i see it.

Char-Lee Wrote:
——————————————————-
> A
>
> there is no interest expense for a zero coupon
> bond, so CFO is over stated.

SEVERELY overstated is what secret sauce says : ) -

Char-Lee Wrote:
——————————————————-
> actually both CFO and interest expense are
> overstated.
>
> Although no coupon payment is made, the discount
> is amortized over the term of bond and interest
> expense is recognized in the income statement….
>
> so interest has to be recognized, it’s the reason
> the CFO is overstated because only the coupon
> payment is reported in CFO (which is zero even
> though there IS an interest expense equal to the
> bond’s amortization).

Let’s get this concept straight. With a normal discount bond, coupon payments are paid out which are less than the int expense and the diff is added to the liability on the balance sheet until it hits par at maturity. Coupon payments hit CFO.

So now applying that to zero coupon bonds, issued at discount, no CFO elements as no coupon payments. So the int expense is recorded and increases the liability on the balance sheet upto par??? Is this correct?