Further to the thread on Alternatives to bond’s yield, I wish to clarify the following:
Question 1: Change in the market rate of interest affect bond liabilities in balance sheet?
My thoughts:
If the _ effective interest rate _ method (U.S. GAAP/IFRS) is used, then any changes in market interest rate will have _ no impact _ on the book value of the bond liabilities; as the book value is based on the market interest rate @ issuance.
If _ SL amortization _ method (U.S. GAAP) is used, changes in market interest rate may have some impact on book value of bond liabilities as the bond’s YTM may be _ slightly different _.
If _ fair value reporting _ (U.S. GAAP/IFRS) is used, any changes in market interest rate _ will have an impact _ on the value of the bond liabilities reported in the balance sheet. Market interest rate @ issuance is no longer relevant.
Question 2: If fair value reporting is used, are there any computation for amortization discounts/premiums?
My thoughts:
If market interest rate increases , market value of bond is < book value of bond; bond will be reported at market value and the _ gain _ (difference between book and market value) will be reported in the income statement.
If market interest rate decreases , market value of bond is > book value of bond; bond will be reported at market value and the _ loss _ (difference between book and market value) will be reported in the income statement.
In either cases, there are no amortization discounts/premiums.
Nope: the market yield still doesn’t matter. The bond’s YTM is slightly different from the YTM at issuance only because the amortization of a premium/discount is different from what it would be using the effective interest rate method.
For example, suppose that a 5-year, $1,000 par, 6% coupon, annual pay bond is issued at $1,100. The YTM is 3.7683%. Using the effective interest rate amortization method, the principle amortization the first year is $18.55, so the book value at the beginning of year 2 is $1,081.45. The YTM remains 3.7683%. However, using the straight-line amortization method, the principle amortization the first year is $20.00, so the book value at the beginning of year 2 is $1,080.00. The YTM at the beginning of year 2 is 3.8061
In my opnion : Prevailing Market Interest Rate at the begining of the accounting period (or the Average Market Interest Rate of the accounting period) x Beginning Book Value of the Bond (or the Average Bond Value).
