Financial reporting analysis 6

[Anshu]

When the market rate of interest falls after issuance, a company selecting the fair value option for reporting a liability with a fixed coupon rate will report:

1. no change.
2. a gain.
3. a loss.

Solution

C is correct. A company selecting the fair value option for a liability with a fixed coupon rate will report a loss when market interest rates decrease.

A is incorrect because a company selecting the fair value option for a liability with a fixed coupon rate will report losses when market interest rates decrease

B is incorrect because a company selecting the fair value option for a liability with a fixed coupon rate will report losses (not gains) when market interest rates decrease.

help me with this question

[HerbsDelite]

Financial reporting analysis 5

You have issued debt worth $ 100 promising to pay a coupon of $8 annually when the market interest rate was 6%. Depending upon your rating the debt is more valuable for the bond holders because of the excess yield over the market interest rate. You know what your liability is. If the interest rate increases to 7% , your debt is no longer that valuable and hence you will record a mark down. This is an accounting effect. A decrease in liability is a good thing to your balance sheet. Regardless a…

[Anshu]

in this case MR decrease

[HerbsDelite]

So take the opposite view. The liability will increase

[S2000magician]

@Anshu

help me with this question

When posting these questions, please let us know that you have put some honest effort into trying to solve them on your own. Let us know your thoughts on the question and the answers.

Otherwise, it feels as if we’re doing your homework for you, and you’re not learning anything.

[Anshu]

When market interest rate falls value of bond rises. Which increases economic liability on company.
Thing I didn’t understand is the meaning of fair value option of reporting a liability

[S2000magician]

@Anshu

Thing I didn’t understand is the meaning of fair value option of reporting a liability

Under the fair value option, the company reports as the value of its liabilities their market value (rather than their original book value adjusted for any amortization).

[Anshu]

When market interest rate falls value of bond rises. Which increases economic liability on company.
So as the economic liability increases = gain in the fair value of options
Right?

[S2000magician]

@Anshu

So as the economic liability increases = gain in the fair value of options

It appears that you’re misunderstanding the phrase “fair value option”.

This has nothing to do with call and put options.

This is an option (a choice) available to companies when they create their financial statements. They have the option (or choice) to report liabilities at their fair value, or the option (or choice) to report liabilities at their historical value adjusted for amortization.

[HerbsDelite]

+1.
To OP, Samaritan like the Magician helps all. Truth be told even I benefitted to some extent during my days of pursuit.

Unfortunately with you, it looks like you are too keen to copy and paste your problem and queries without having the intent of attempting or at least letting us know your viewpoint. Not sure how that helps.

This forum will definitely help you. Make the most of it. Lastly a vote of thanks don’t cost much. Have not seen many from your end for all the free services you are availing of. ( Don’t be discouraged but perhaps you could show some appreciation after each of your query is addressed to satisfaction)