I am trying to understand why the answer to Problem 17 of Reading 21 is NOT choice A. Can someone please help me out here? Remeber, the question is asking about interest income — not about any income that may or may not be recognized due to changes in market value. Assuming that the Bugle AG bond has a par value of EUR 28,000 and keeping the same cost at EUR 25,000, it would appear the Confabulated has purchased the Bugle AG bond at a discount. Now the Bugle AG bond is classified as available for sale, which means that the entire coupon payment (regardless of whether the bond was purchased at a discount, at par, or at a premium) is recognized on the income statement as interest income. With a new par of EUR 28,000 you would think that (assuming we use the same nominal coupon rate), the coupon payment would be bigger – in which case reported interest income on the income statement would be bigger. But, apparently, that is not the correct choice. Why?
Held to maturity security is the one that would have a higher impact. That is where the amortization would occur. and between the two Held to maturity Cathay becomes a discount bond - with 37K Par, 40K Cost. While Dumas becomes a premium bond with 50K Cost and 55K as the Par value now with this problem. hence answer is C.
Becaue - Dumas is HTM Debt security and when the cost on book was 50K and the Par Value was 55K, means Confabulated purchased the security at discount to par. This INT would comprise of 2 parts - CPN pmt + discount amortization
Hi, CP. Thanks for the feedback. I have two observations about your response: (1) With respect to Cathay, your observation that “37K Par, 40K Cost” makes Cathay a discount bond seems counterintuitive. If I pay EUR 40,000 for a bond whose par value is EUR 37,000, would I not be paying a premium? (2) So are you saying that for Choices A and C that reported interest goes up, but that the increase is greater under Choice C? Thanks, Cadlag
in the absence of interest rates… assuming that both Cathay and Dumas had the same coupon rate = 55*X > 37*X so Dumas would have a higher impact on interest cost. and yes both are discount bonds… my bad. for an available for sale security - the interest income would be par value into original coupon at issuance - look at the example 1 on page 13 - 14 (esp. the top part of page 14). There interest income = 275K * 6% = 16500. here par is increasing so again an x% of 28K < x% on 55K.
Bugle is a Discount bond Cathay is a Premium bond Dumas is a Discount bond Cathy is out of question as it’s a Premium bond and will reduce Interest income. For other 2, INT = PAR*(Market Rate as Issuance) 28*x < 50*x Dum-ass wins!