No spec if ic asset s are pledged as sec urit y f or

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: ion. No spec if ic asset s are pledged as sec urit y f or debent ure bonds, sec ured bonds on t he ot her hand is bac ked by a lien on spec if ied asset , e.g., mort gage bonds are sec ured by a c laim on real est at e. Ot her t ypes of bonds inc lude c onvert ible, regist ered, c oupon, c allable, and various ot her t ypes are list ed on pages 910–911. Dif f erent t ypes of bonds are issued t o at t rac t c apit al f rom various invest ors and risk t akers. Measurement and Valuat ion of Bonds Payable https://blackboar d.tr u.ca/webct/ur w/lc5122001.tp0/cobaltM ainFr ame.dowebct 3/9 9/10/13 Blackboar d Lear ning System Long- t erm debt is measured at f air value on init ial rec ognit ion, inc luding t ransac t ion c ost s. Subsequent ly, t he inst rument s are measured at amort ized c ost or in c ert ain limit ed sit uat ions, f air value, under f air value opt ion. Bonds c ont ain t wo set s of c ash f lows: A series of int erest payment s t hat are based on t he int erest rat e st at ed in t he bond indent ure (t he c oupon rat e). Sinc e t he payment s are of equal value and are rec eived at regular int ervals, t hese c ash f lows represent an ordinary annuit y. A single lump- sum payment payable when t he bond mat ures. T his downst ream payment represent s a f ut ure value. T o det ermine t he value of t he bonds on t he issue dat e, we need t o c alc ulat e t he present value of bot h t he annuit y and t he lump- sum payment . T hese c ash f lows are disc ount ed at t he market rat e of int erest (also known as t he ef f ec t ive rat e of int erest or t he disc ount rat e). As an aside, t he market rat e of int erest is t he ret urn demanded by lenders t hat f ac t ors in t he risk of def ault , t he sec urit y pledged, and t he lengt h of t ime t o mat urit y. If t he c oupon rat e is t he same as t he market rat e of int erest , bonds will be issued (sold) at “par.” Anot her way of looking at it is t hat t he c redit or will lend $1,000 f or every $1,000 bond when t he bond is paying t he same rat e as t he c redit or want s t o earn. If t he c oupon rat e is higher (e.g., 8% per annum) t han t he market rat e of int erest (e.g., 6% per annum), t he bonds will sell f or more t han t heir f ac e value; t hat is, t he bonds will sell at a premium. T he reason f or t his should be f airly obvious—people are willing t o pay more f or a bond t hat pays int erest of $40 every 6 mont hs t han t hey are f or a similar bond t hat only pays $30 every 6 mont hs. If t he c oupon rat e (e.g., 4%) is lower t han t he market rat e of int erest (e.g., say 6%), t he bonds will sell f or less t han t heir f ac e value; t hat is, t he bonds will sell at a disc ount . Again, t he reason f or t his is int uit ive—people are not willing t o pay as muc h f or a bond t hat is only paying $20 every 6 mont hs as t hey are f or a similar bond t hat pays $30 every 6 mont hs. Bond pric es are quot ed as perc ent age of f ac e value. F or example, let ’s look at a $1,000 bond: Bonds selling at 100 are t rading at par and c an be purc hased f or 100% of f ac...
View Full Document

Ask a homework question - tutors are online