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Topic: Bond Pay. Ques. - from Becker Sim. (

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Crammer
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Posted: 11 Nov 2009 at 15:55 \| IP Logged

This came from Becker Ch. 5 Simulation (Calculation tab):

Assume that on Jan. 1 Scott, Inc. issued a 7%, $50K bond due in 5yrs. The market rate for similar bonds is 6%. Scott, Inc. pays interest semiannually on Jan.1 and July1. Various PV interest factors have been provided to you below (below).

PV of 1 @ 3% for 10periods = .744

PV of an annuity of 1 @ 3% for 10periods = 8.530

-------------------------------------------------

PV of the face amount of bonds = 50K *.744 = $37,200

PV of future interest pmts = [(50K*7%)/2]*8.530= 14,928

Total issue price = 52,128; sold @ a premium.

Okay - makes sense except for how they calculate the PV of future interest pmts. I calculated as:

$50,000 bond/5yrs = 10,000 annual pmts /2 = 2,000 semiannual pmts.

therefore, $2,000 * 8.530 = 17,060. So, I'm still calc it as a premium but the issue price is off - is my way of calculating this not correct??

Thanks for your help!

lovethepirk
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Posted: 11 Nov 2009 at 16:10 \| IP Logged

You are just off in your understanding of how the Bond works....easy fix :)

You wire transfer 50,000 to a company and they give you a bond! Sweet!

Every 6 months you get a return on your investment, that's it, nothing more, you do not get your investment back, YET. The company still holds your initial investment b/c they need that money to be working for them(new projects, funding lavish dinners for overpaid executives) hahahah

If do this 50,000/5=10000 you are saying the company is paying back some of the principle to you, they don't do that. They only pay you interest on the bond and after 5 years you will get your 50,000 back, assuming the exec's didn't loose all your money leveraging credit swaps :)

So you need to discount the 50,000 back 10 periods. And discount the interest you are receiving back 10 periods as an 'annuity'.

==========

Remember they keep the principle until the end of the bond term or the call the bonds or there is a conversion into stock or something.

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FutureFL-CPA
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Posted: 13 Nov 2009 at 13:09 \| IP Logged

Thanks for the explanation lovethepirk, I even benefited from this one!! I posted earlier I was having a hard time understanding this subject and my test its on the 30th!!

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Crammer
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Posted: 13 Nov 2009 at 13:31 \| IP Logged

Okay - I'm still confused!!!! ahh.

I get that you need to have the principal AND the interest payments discounted to PV. The Principal is discounted using PV of $1 (because only 1 FULL pmt at the end of term) and interest is discounted using PV annuity factor because of periodic payments being made to the borrower.

I'm using Becker - and in Ch. 5/p.37 is an example of calculating the selling price. I'm not sure where I'm getting mixed up - cause it appears I'm calc. the way the example shows?? Please help!

lovethepirk
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Posted: 13 Nov 2009 at 15:45 \| IP Logged

FutureFLCPA,

Your welcome, what part of FL you in. I am in Naples for the time being...might be looking for work here in a week. I have lived in O town for 3 years previously...Metro west area...

Crammer,

Interest is not taking the bond price of 50,000 and dividing it by years.

WHATEVER the stated rate of interest on the bond is what you multiply the standard bond price by to get how much is ACTUALLY PAID OUT

So our bond is a "50,000" bond with a stated rate of 7%

Yearly interst PAIDis 7% * 50,000 = 3,500
Semi anuually PAIDit is...................1750

Now step back from this problem a second and imagine the market rate of interest is 30%, OMG!!!! Would you invest in this bond at 7% or put your money in a CD at the bank getting 30%. NO BRAINER...

So to entice the investors to buy this bond that was stated at 7% they must make it much cheaper to buy, so that when the investor gets the 50,000 principle back they make a massive gain on the purchase price as well as the crappy 7% interest they made every year. That massive gain gets them up to the 30% market rate in essence.

For this reason you take your principle and your REAL PAYMENTS and discount them back with the current market rate so we can find that golden price that will attract investors.

Your problem is opposite my example in that the market rate is 6% and the stated rate is 7%. That means that this company is PAYING OUT 7% yearly interest when the market is only paying out 6%. Well....hell who in there right mind wouldn't buy the bond!!!! So the bond price goes up....and hence you have a bond premium.

__________________
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Using Wiley books and CPAnet!!!

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