how do you work out what price a bond will be redeemed at? i thought they are just returned at the face value/par value? thus any premium/discount initially received when issued would cause a gain/loss on the on the income statement if redeemed early as the premium/discount would not have been fully amortised away.
the question i am referencing is below with the answer.
many thanks
“Harter Corporation issued $95 million of 10-year 8% coupon bonds in 20X5. In 20X5, the market interest rate was 6%. The current market interest rate is 9%. Harter has generated unexpectedly strong profits over the last several years. Given a high cash balance, the company is considering repurchasing the entire bond issue. If Harter repurchases the bonds, what is the immediate effect in Harter’s income statement?”
The bonds were issued at a premium in 20X5 because the 8% coupon rate exceeded the 6% market interest rate. Since the current market interest rate of 9% is above the coupon rate, Harter can repurchase the bonds at a price below the carrying value. When the carrying value exceeds the reacquisition price, a gain is recognized in the income statement.
so is the point that the bond can be bought at a discount since the coupon rate is below the market interest rate? Therefore it is a gain in the income statement? Sorry new here.
my understanding (and happy to be shown otherwise) - when the interest rate increases above the coupon rate, the market price of the bond falls allowing the company who originally sold the bond (FV at the time of sale will be the carrying value adjusted for any amortised premium or discount) to buy it back cheaper and realise a profit on the income statement.
so if the interest rate increased to 8% rather than 9% in the example, would it still be bought at a discount price and be a gain on the income statement?
They would not be bought at a discount; they would be bought at par (because the coupon rate equals the yield). However, because they were issued at a premium, the issuer would still record a gain.
I understand the par value correctly now, but how does it still provide a gain or I guess, how would it be recorded exactly as a gain? Is this just because the interest expense is decreased.
Assuming semiannual pay bonds, they were issued at a price of $109,133,601, with a premium of $14,133,601.
After, say, 5 years, the premium will have been amortized down to $8,103,693 (using the effective rate method). At a yield of 9%, the market price of the bonds would be $91,241,459. If they were able to repurchase all of the bonds, the journal entry would be:
Debit
Bonds Payable $95,000,000
Premium on Bonds Payable $8,103,693 Credit
Cash $91,241,459
Gain on Redemption of Bonds $11,862,234