coupon is 6% market interest is 7% 4 years maturity thanks.
If it’s semiannual payments, and assuming $100 par, the 6% bond pays $6 per year, or $3 per payment period. Four years is 8 payment periods. Interest rate is 7. So, do the following: f FIN (to clear the finance registers) 8 n 7 i 3 PMT 100 FV PV Display shows -76.11 One problem is keeping proper use of signs. From Point of View of bond holder, payments are positive (received), future value of $100 is received too, so the Present Value is negative (you have to pay for it).
Oops, interest rate should be 3.5, not 7, since it’s semiannual. This gives PV of -96.56
Thanks a lot. Thank you very much
It’s interesting that the accounting part don’t count coupon payment as interest expenses (to me that’s the interest I pay on the bond I issued), instead, they use book value of bond multiply by market rate at issue time. Intuitively this confuses me.
I believe the rationale behind this is that the true “interest” for the bond paid by the firm is not merely the coupn payment. For instance, imagine if a firm issues zero-coupon bonds. Then, according to the logic of coupon pmt = interest paid, the firm will never accrue any interest until the difference between the principal received at issuance and the face value needs to be accounted for at maturity. i.e. n=10 i=5% PMT=0 FV=100 then PV=61.39 So the firm would receive 61.39 for this bond at issuance. At maturity, the firm must pay 100.00. So, without accruing interest on the basis of BV x YTM, the firm would record the entire interest ($38.61) in the year of maturity. This fails to satisfy the principles of accrual accounting.
shuzhen Wrote: ------------------------------------------------------- > It’s interesting that the accounting part don’t > count coupon payment as interest expenses (to me > that’s the interest I pay on the bond I issued), > instead, they use book value of bond multiply by > market rate at issue time. Intuitively this > confuses me. Read aramin’s answer above and think about it. This is a really fundamental example of accrual vs cash accounting. Just because you didn’t pay the expense doesn’t mean you didn’t have it…
Joey, I understand Aramin’s example and reasoning above. In the case of a coupon bond, every 6 months there would be an accounting entry First 6 month period Interest Expense***DR***Coupon Amt ***Accrued Interest***CR***Coupon Amt After 1 Year Interest Expense***DR***Coupon Accrued Interest***DR***Coupon ***Cash***CR***2*Coupon In a zero coupon bond, all of the above entries would be with 0 amounts. So that part looks good. But, wouldn’t an Amortization Expense appear as well on the Income Statement? (For the entire Bond Liability * Market Rate at Issuance? (which would make its way into the CFO statement using the Indirect method)) Thanks CP
I think your issues are a little different than what shuzhen is asking about… Yep amortization expense appears as part of interest expense on income statement and yep for discount bonds that causes CFO to be overstated and yep you’re supposed to adjust for that by moving amortization into CFF from CFO.