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With a fixed principal payments plus interest loan, this is exactly what it says. You will pay the sameamount of principal off each month. For instance, if you borrowed $27,000 for a three year term, youwould pay $27,000/36 = $750 on the principal each month, plus applicable interest. Again, as you goalong and pay more off the principal each month, the interest will reduce. This means that yourpayments will reduce as you go along. You will start out paying larger payments than if it were ablended payment, but as time goes by, the payments will become smaller.10 - 42
Reporting and Analyzing LiabilitiesS-A E 181When determining the issue price of a bond using present value, what are the two components used inthe calculation?Solution 181One component is the periodic interest payments over the life of the bonds, discounted using themarket interest rate to calculate the present value. The other component is the present value of theface value to be paid at maturity, also based on the market interest rate.S-A E 182When a bond sells at a discount, what is probably true about the value of the market interest rateversus the coupon interest rate? Discuss.Solution 182For someone to purchase a bond at a discount, the coupon interest rate normally must be below themarket interest rate for similar bonds. Investors will make up the difference by paying less than the facevalue of the bonds.S-A E 183Bonds are frequently issued at amounts higher or lower than face value. Describe how the marketinterest rate, relative to the coupon interest rate, affects the selling price of bonds.Solution 183The market interest rate is often different from the coupon interest rate, and therefore bonds arefrequently issued at amounts higher or lower than face value. When the market interest rate is higherthan the coupon interest rate, investors can find better investments elsewhere, and consequently thereis less demand for the bonds. So to make the bonds more attractive, the issue price will be lowered andthe bonds will be issued at a discount. Conversely, if the market interest rate is lower than the couponinterest rate, there will be greater demand for the bonds because of the higher interest rate. Thus, theissue price will be higher than face value and the bonds will be issued at a premium.S-A E 184Bonds may be redeemed (retired) before maturity by the issuing corporation. Explain why a companywould decide to retire bonds before maturity and the steps necessary to record the redemption.Solution 184A company may decide to retire bonds before maturity to reduce interest cost and remove debt from itsstatement of financial position. A company will retire debt early only if it has sufficient cash resources.When bonds are retired before maturity, it is necessary to:1.update any unrecorded interest & amortization2.eliminate the carrying amount of the bonds at the redemption date3.record the cash paid, and4.recognize a gain or loss on redemption. The gain or loss is the difference between thecash paid and the carrying amount of the bonds.