FAR-F5-M4-Bonds Part 1 Flashcards
What are the different types of bonds?
The different types of bonds are:
1. Secured bonds: a secured bond has a claim to specific assets.
2. Unsecured bonds: has no such claim and the bondholders are unsecured creditors
3. Serial bonds: bonds that mature at staggered intervals.
4. Single maturity bond: a bond with a single maturity date
5. Callable and redeemable bonds: bonds that can be matured before the maturity date at a specified price.
6. Convertible and nonconvertible: a convertible bond can be converted into stock.
What is the difference between serial bonds and term bonds?
Serial bonds are those issued with scheduled maturities at various dates.
Term bonds are issued with a single fixed maturity date.
What are bonds with detachable warrants?
With bonds with detachable warrants, the proceeds from the issuance are allocated to the
1. fair value of the warrants without the debt (paid in capital-equity)
2. the fair value of the debt instrument (classified as debt)
If ABC issued $100,000 of bonds at 97, then the bonds were issued at a discount or premium?
If ABC issued $100,000 of bonds at 97, then the bonds were issued at a discount.The Present value of the bonds aka the cash proceeds is $100,000 * .97 = $97,000, with a $3,000 discount.
If ABC issued $100,000 at 102, then the bonds were issued at a discount or premium?
If ABC issued $100,000 of bonds at 102, then the bonds were issued at a premium. The present value of the bonds aka the cash proceeds is $100,000 * 1.02 = $102,000, with a bond premium of $2,000.
For bond problems, what does the coupon rate aka the stated interest rate represent? How does it differ from the effective rate aka the yield rate aka the market rate?
The coupon rate or stated interest rate determines the actual cash interest paid by the bond.
The market rate determines the interest expense and the bond price.
If the market rate is greater than the stated rate of a bond, then is the bond issued at a premium or a discount?
If the market rate is greater than the stated rate, then the market is paying more interest than the bond, therefore the bond is valued less than other bonds in the market, therefore the bond price is lower than the market, therefore the cash proceeds is less than the face amount of the bond, therefore the bond is issued at a discount.
Example of JE:
Dr. Cash XXX
Dr. Discount on Bonds Payable XXX
Cr. Bonds Payable (XXX)
If the market rate is lower than the stated rate of a bond, then is the bond issued at premium or a discount?
If the market rate is lower than the stated rate, then the market is paying less than the bond, therefore the bond is valued more than other bonds in the market, therefore the bond price is higher than the market therefore the cash proceeds are more than the face amount of the bond, therefore the bond is issued at a premium.
Example of JE:
Dr. Cash XXX
Cr. Bonds Payable (XXX)
Cr. Premium on Bond Payable (XXX)
If the market rate is the same as the stated rate, then is the bond issued at a premium or a discount?
If the market rate is the same as the stated rate, there is no premium or discount.
What rate is used to calculate the bond price?
The bond price is the present value of the future cash payments discounted at the market rate.
To calculate the bond issue price aka the market value of the bond, issued at either a discount or a premium is the present value of 2 cash flows. What are those 2 cash flows?
The general rule to calculate the bond issue price aka the market value of the bond issued at either a discount or a premium is the present value of
- the present value of the principle which will use the PVF of $1 at the appropriate n periods and MARKET RATE.
- The present value of all future interest payments, in which the interest payment is the face value of the bond * the stated interest rate. Then the interest payment is discounted at the MARKET RATE.
Regardless of whether a bond is issued at premium or a discount, the premium or discount must be amortized using the effective interest method. What is the general format of the table in order to calculate the ending carrying amounts of bonds payable?
Year / Beginning Carrying Amount of Bonds Payable / Market Rate / Interest Expense (beginning carrying amount * market rate) / Cash Paid ( face value of bond * stated interest rate) / Discount Amortized (difference between the interest expense and cash paid) / Ending Carrying Amount (beginning carrying amount - discount amortized)
If the bond is issued at a premium, then the amortization of the premium will decrease the carrying amount of the bond until the carrying value of the bond reaches the face value of the bond.
If the bond is issued at a discount, then the amortization of the discount will increase the carrying amount of the bond until the carrying amount of the bond reaches the face value of the bond.
Using the effective interest method, how do you calculate interest expense?
Beginning carrying amount of the bond * market rate = interest expense.
Internal note: If the problem offers an effective rate, then use the effective rate instead of the market rate.
Using the effective interest method, how do you calculate the interest payment?
face amount of the bond * stated interest rate = interest payment aka actual cash paid aka interest payable.
What are bond issuance costs?
Bond issuance costs are transaction costs incurred when bonds are issued. Examples include legal fees, accounting fees, underwriting commissions and printing.
