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Bond Problems

For all the following multiple choice questions use the following information:

ABC Co. issued a bond some time ago with a coupon rate of 10%. The market interest rate was then 11%. The bond is not due to mature for some time. The current market interest rate is 9%.

(Your answer must be supported by a concise explanation.)

1. The bond was issued at: (a) a premium; (b) a discount; (c) at par; (d) Cannot say.
Explanation:

2. The interest expense reported by ABC will:
(a) increase over time; (b) decrease over time; (c) stay constant; (d) cannot say without more information.
Explanation:

3. Relative to its face (i.e., par) value, the current market value of the bond is:
(a) the same (b) lower (c) higher (d) Cannot say.
Explanation:

4. Relative to its net value in ABC's books, the current market value of the bond is:
(a) the same (b) lower (c) higher (d) Cannot say.
Explanation:

5. If ABC purchases back the bond at market value and retires it, it will report:
(a) an gain on early retirement of debt; (b) a loss on early retirement of debt;

(c) neither a gain nor loss; (d) Need more information to determine the accounting effect.
Explanation:

Given below are excerpts from A CME company's income statement and comparative balance sheets for the year 2000.

Income statement for the year 2000
Interest expense 7,000
Gain on retirement of bonds 2,000
Balance sheet ended Dec 31, 1999 Dec 31, 2000
Net Bonds payable 160,000 180,500

ACME also reported that bonds with a book value of $21,000 were retired during the year, and that new bonds issued during the year brought in $42,000.

Required. 1. Showing your computations in the space below, report what the cash flow statement for the year 2000 (direct method CFO) would show for bond related items under:

Operations:

Financing:

Space for computations:

2. In the reconciliation of NI to CFO, what bond related items would appear and how?

Solution Preview

Please see the responses in the attached document.

1. The bond was issued at: (a) a premium; (b) a discount; (c) at par; (d) Cannot say.
Explanation: (b)
The effective interest rate at the time of issue (11%) was greater than the coupon rate of 10%. Thus, the Present Value of the bond was less than the par value. Because of this reason, the bond was issued at a discount.

2. The interest expense reported by ABC will:
(a) increase over time; (b) decrease over time; (c) stay constant; (d) cannot say without more information.
Explanation: (a)
As the bond nears maturity, the book value will become close to the par value. Interest expense will be calculated as 11% of the carrying value of the bond. As, the carrying value increases over time, the interest expense associated with the bond will also increase over time.

3. Relative to its face (i.e., par) value, the current market value of the bond is:
(a) the same (b) lower (c) higher (d) Cannot say.
Explanation: (d)
Generally, the current market value of the bond should always be less than the face value as long as the market rate remains higher than the coupon rate. But in this particular case, the market rate became less ...

Solution Summary

Several Bond Problems that explain the the concepts of market value, prices, yield to maturity

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