I don’t understand why must calculate “amortisation” for discount/ premium over life of bond?
Matching principle: a premium is a gain earned over the life of the bond, and a discount is a loss incurred over the life of the bond.
Thank @S2000magician
However, May I mis-understood or unclearly abt " matching principle", I still wonder why gain and loss must amortise (sorry if I am too stupid).
Under Fair value method, the bond’s yield changes --> fair value of the bond is unequally over the life of bond. That is rational.
Wheareas, Under Book Value of the bond liability method, assuing that the bond’s yield unchanged. So, The discount and premium at issuance won’t be changed too and it should not amortise discount/ premium.
Where I am wrong?
Amortization accounts for the difference between actual coupon payments and the effective interest rate at which debt is issued.
When a bond is issued at a premium, the lender’s effective interest rate is lower than the stated coupon rate. For eg. if a $100 par bond paying 5% coupon annually is issued at $110 ($10 premium), the premium received effectively subsidises the 5% coupon paid over the life of the bond because the lender repays $100 at maturity as against $110 received upfront. Vice versa for discount bonds.
Since the effective interest rate benefit (for bond issued at premium) / penalty (for bond issued at discount) accrues over the life of the bond, the premium / discount is also amortized over the life of the bond. This is the matching principle.
@oz001: thank much
I re-read matching principle and understand. Your explaination is so clearly and detailed 