Here comes my old enemy: Held to maturity, Held for trading, Available for sale
I came across this questions in CFAI EOC for Reading 18, Questions 1. It’s supposed to be a very basic question but I’m a bit lost. Where in notes / books does it say which value (market value? cost?..) should be used to for Held to maturity, Held for trading, Available for sale items when calculating the carrying value of an investment portfolio?
Thanks in advance!
On the purchase date everything is at fair value (if you know what I mean). During subsequent year ends they remain at fair value except HTM, which is at amortized cost. It is the income statement/OCI that complicate matters.
Oh so the questions was asking about their balance sheet figure?!
Yes carrying value is your balance sheet figure.
In accounting usually carrying value is synonymous with book value, but when book value is equal to fair value you get
carrying value=book value=fair value
Ok got it! Thanks a lot.
@Krok - I am having trouble hacking through this whole reading. Do you think it’s worthwhile to go back to L1 to help? Or is it just about learning rules.
Also, in the curriculum i see a lot of rules (i.e. “if … this then …use this method” etc.) but not many examples of calculations, for example calculating interest and the amortised cost. Is it mainly just about knowing which rules to use under given circumstances?
Apologies if the second part sounds stupid, i haven’t completed the reading.
There is no point in going back to L1 because this topic is not there. In general going back is not advised unless you have tonnes of time.
I am afraid accounting is largely memorization. Even chartered accountants always keep an IFRS/GAAP manual at hand to always make a reference because the whole framework is a massively branching protocol that must be followed. As you probably figured I try to summarize all concepts in the form of tables to try to create rules that can be pictured rather than remembered.
However, if you want to understand how bond amortization is calculated then you have to practice examples. Go outside the curriculum if necessary. Google it, Youtube it. You may think you understood the concept but when it comes to calculating you may be stuck because you have never done an example!
Yeah, Intercorp Investments is very rules based.
For HTM securities, the key principal is understanding what is hitting Profit and Loss, and how carrying value may need to be adjusted.
Profit and Loss is easy, as it’s simply the coupon payment.
Carrying value is based entirely on whether the debt security was purchased at par (no adjustment needed), a premium (amortize the premium down) or a discount (amortize the discount up). If the security was purchased at a premium, it means the YTM on the bond was lower than the coupon rate when purchased. A higher coupon than the YTM will reduce the premium towards par over the remaining term of the bond. Vice versa when purchased at a discount.
So for example (using Wiley’s simple example on the effective interest rate method):
A bond is purchased for $240,000 which has a 7% coupon and $200,000 par value (purchased at a $40,000 premium). The market interest rate (YTM) when the bond was purchased was 5%. In the following year:
Beginning carrying value = $240,000
Coupon Payment received = $200,000 x 7% = $14,000
Interest income = $240,000 x 5% = $12,000
Amortization of premium = $14,000 - $12,000 = $2,000
So, carrying value at the end of the first year is $240,000 - $2,000 = $238,000
If the bond was purchased at a discount, interest income would be higher than the coupon, and you would add the difference to the beginning carrying value (heading up towards par).
Hope that helps!
In case some candidates don’t know, bond amortization can be smoothly done on a BA II (that’s what I use). Try it if you haven’t.
Type the following TVM inputs I/Y =5% PV =-240,000 PMT =14,000 FV =200,000 CPT ->N, N = 14.21 This is the maturity of the above bond. Now press 2ND+PV to enter AMORT mode. It prompts you to specify period start and period end. So P1 =1, P2 =1 for first year. After that you just browse through BAL ance, PRN cipal and INT erest using up down arrows.
It might not be…
Definition of fair value (IFRS), sorry about my English in advance…
“…fair value is value which will be determined between non-related, well informed parties in transaction before settlement”
Suppose by your thesis above that parent sold and asset to subisidiary (or company owner to own firm) above or below its market value (transfer pricing) , or the purchasing price was in any other manner biased. Then, that’s not fair value.
By each classification category you have distuingish so called “beginning recognition” and “measuring”.
Krokodil explained well to simplfy process for beginning recognition (and am sure that’s always case in curriculum) is market purchasing price as beginning BV.
Measuring (in periods after initial recognition) is the key difference among categories.
HTM - measured upon amortization expense, thus market value does not interest you. You simply amortize an asset thus
BV is an asset purchasing price - acummulated amortization.
AFS - measured upon market (fair value), thus each nonrealized gain/loss at each balance date in further periods
is a difference between current asset market value on BS date (eg. 31/03, 30/06,30/09, 31/12 or whatelse) and balance sheet BV. Remember that the asset BV is last recored BV upon last taken change (f.ex. on 30/06 your BV would dated on 31/03), not longer initial BV formed by purchasing an asset.
FVtPL (AFT) - same as AFS but measurement is proceed through Income statement (P/L), not through equity position (OCI) as AFS.
Each cash flow (dividend/interest) should be proceed through Income statement upon each classification category.
Thank you very much for the calculation method… Have you figured out a way to calculate swap fixed cost easily. It takes time and cumbersome