held to maturity securities

CFA Level II
#1

I have 2 questions:

  1. What is the treatment for coupons received for held to maturity securities, let us say for a discount bond?

  2. What is the treatment for profit/loss arising out of sale of held to maturity securities?

Can someone please explain??

#2

Held-to-maturity securities are not intended to be sold prior to maturity. If a company does, then it is prohibited to account for held-to-maturity securities in the future.

When you account a discount bond, you must amortize the discount over the life of the security through the interest income recognition in the income statement (interest income = cash coupon amount + amortized discount/premium). The coupon is cash, so it is accounted as an operating cash inflow in the Cash Flow statement, this apply for US GAAP and IFRS though.

If you get a profit or loss from the sale of a HTM security, you must recognize it in the income statement. And the proceeds from the sale are accounted as an investing cash inflow in the cash flow statement.

Hope this helps.

#3

Coupon payments and dividends are _ always _ recognized on the income statement, irrespective of the treatment of the security (HTM, AFS, HFT).

Realized gains and losses are _ always _ recognized on the income statement, irrespective of the treatment of the security (HTM, AFS, HFT).

#4

The prohibition against using the HTM category occurs when and only when _ a significant portion _ of HTM securities are sold prior to maturity; it isn’t automatic on any sale.

#5

Thank you everyone yes

#6

My pleasure.

#7

You are totally right, I didn’t have that part clear enough. Thanks.

#8

My pleasure.

Although it isn’t mentioned in the curriculum, the same prohibition can occur if the held-to-maturity securities have embedded options (e.g., put options, conversion options) that the bondholder exercises prior to maturity. The SEC encourages investors _ not to designate_ putable or convertible bonds as HTM.

#9

Indeed, this case is not mentioned in the Curriculum, didn’t know that info, thanks.

One thing I don’t get at all is that if a company invests in a long-term security with an embedded option, it is indeed the bondholder and has the right to exercise the option. So what is the difference from having a non-embedded one? In both cases the bondholder could be able to sale the security and break the HTM rule of not selling good portion of it (assumption). What I think is that an embedded-option security can be much more desirable/attractive to sale in certain cases than selling one that does not have an embedded option. Is my logic correct?

Thanks!