I’m new to the forum. Quick clarifying question on Bonds. I understand that: Market rate of interest = stated rate of interest = PAR BOND Market rate of interest < stated rate of interest = PREMIUM BOND Market rate of interest > stated rate of interest = DISCOUNT BOND The CFAI book says " If the stated rate of interest when the bonds are issued is higher than the market rate, the market value of the bonds, and thus the amount of cash the company receives will be higher than the face value of the bonds. In other words, the bonds will sell at a premium to face value" I’d like to make sure I have the concept right. Does this mean that let’s say a bonds par value is $1000 and if a bond is issued at a premium the company will get proceeds of let’s say $1,100 at issuance but at the end of maturity only needs to pay $1,000?? Simple concept, but I’m getting confused! Thanks for any clarification!!
Yes
Yes, since the bond issued at the higher coupon rate than the market rate, the amount of higher coupon payment (higher interest payment over interest expense) will offset the surplus of proceed. example: bond face value $100000 issue at 7% coupon annually for 5 years, the market rate is 6%. The price of bond is $104212. The interest expense is $104212 x 6% = $6252.72 while the interest payment (coupon) is $7000. The difference between them is the amount of amortization except in this case we subtract amortization from the book value of the bond to &100000 at maturity rather than adding.
Thank you wyantjs and manowar!!! Manowar, just the explanation I was looking for…thanks a lot! Two follow up questions 1) The difference between interest payment vs. interest expense. I know interest payment is coupon rate * face value and is the interest a company pays to a bondholder at periodic intervals. The interest expense is market rate * book value. But, what is the exact difference here? Who is the company paying this “interest expense to?” 2) Secondly, can you explain why amortization is added to book value for premium bonds and subtracted for discount bonds. I’m not sure I follow this very well. Thanks for your help!
Dear e2Icfa 1- interest expense based on the book value of the bond appears in the income statement along with bond amortization. Interest payment based on the coupon rate relatively to the face value is the amount the bondholders actually received. It appear in the cash flow statement. Under US GAAP, it belongs to CFO, IRFS allows CFO of CFF. 2- For bond issued at discount (face>price), amortization is added to the book value until maturity when the book value = face value. Because interest expense > interest payment. - For premium bond, (face
Excellent! Thanks a lot manowar!! Very helpful.
I’ve found that this principle is right but when record in accounting accounts, it is a little bit different. The Bond payable account is recorded as the face value plus with discount (premium) on bond payable, a contra account. The book value, the carrying value equals the face amount minus or add any unamortization of the discount or premium on bond payable.