Joined: 26 Apr 2007 Location: United States
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Posted: 18 Jan 2009 at 16:22 | IP Logged
cmjuneja wrote:
could not understand the stuff with amortizations etc
plez help
i am with you, i am not getting a single thing on "bonds", do you guys suggest going to MCQ's or should i look some other books and then do MCQ's. i am totally freaking out.
Joined: 28 Aug 2008 Location: United States
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Posted: 19 Jan 2009 at 00:56 | IP Logged
Jams wrote:
cmjuneja wrote:
could not understand the stuff with amortizations etc
plez help
i am with you, i am not getting a single thing on "bonds", do you guys suggest going to MCQ's or should i look some other books and then do MCQ's. i am totally freaking out.
Count me in.
I don't even know where to start to make my flash cards. This is so discoraging :( I am so tired of reading over and over.
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Posted: 19 Jan 2009 at 03:01 | IP Logged
The tricky thing about bonds is you have 3 rates of interest at play: 1) The contract rate 2) The effective interest rate (rate you are actually getting) 3) Market interest rate
So let's assume you are considering buying a $1000 bond with a contract rate of 10% that matures in 5 years. This means that you will get interest of $100 ($1000 * 10%) each year. You will also get $1000 back at the end of 5 years. Now, if you paid $1000 for this bond at the beginning, the effective interest rate (rate you are actually getting) would be the same as the contract rate, 10%. BUT, you are usually not going to pay the exact amount due to the market interest rate. Let's assume the market interest rate is 15%, meaning you can buy another type of investment on the market that will get you 15%. Well then who is going to buy the 10% bond for $1000? The answer is: nobody! So the price of the 10% bond needs to be lowered below $1000 so you are effectively getting a higher return for your money. So the price of the bond will need to be lowered so the effective rate of interest on the bond equals the market rate of interest, in this case 15%. Lets assume that this means the bond will sell for $800 (just made that figure up, you have to use PV calculations to figure it out). The difference between the face value of the bond ($1000) and the selling price ($800) is called the discount. This discount of $200 is extra revenue for the buyer that is amortized over the life of the bond.
When considering amortization, it is important to remember that your revenue from the bond each year has 2 components, the interest payment for the year and the part of the $200 discount that will be amortized that year. So if your supposed to be making 15% per year, then your interest revenue for the first year is $120 (15% * $800). $100 of that was the yearly interest payment, so the remaining $20 is amortization of the discount. For year 2 it repeats, we now have $920, so the interest revenue for year 2 is $138, meaning $38 of the $200 discount is amortized for year 2. The rest of the discount will be recognized as revenue over the life of the bond.
Ok, now lets assume that the market rate is 5%. This means the contract rate of 10% on the bond is absolutely outstanding compared to the rest of the market. So the seller can charge extra money for the bond. Again, the selling price of the bond should make the effective interest rate of the bond equal the market rate. Lets assume it sells for $1300 (again, I made that figure up). The $300 difference is called a premium. For the buyer this is an "expense" that is amortized over the life of the bond by offsetting it against the interest revenue.
I have to stop now, my head hurts. Hope this helps.
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Posted: 19 Jan 2009 at 11:38 | IP Logged
One really thing important to know is that what you get paid cash (stated rate) and what your effective interest rate are - are two different amounts. The difference between those two amounts is the amount that must be amortized each period until finally, your bond on the books is equal to its face value.
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Posted: 19 Jan 2009 at 11:40 | IP Logged
one other thing - if you just dont get a certain subject and you just cant grasp it - no matter what - just skip it - in my opinion. its not worth the "brain space". not everyone can learn everything.. my two tricky subject were forgein exchange and consolidations and rather than killing myself over them - i skipped them.. chances are you'll be fine..
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Topic: Questions - Bonds
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