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Human Capital - Reporting and Interpreting Bonds

By:   •  December 10, 2018  •  Essay  •  9,480 Words (38 Pages)  •  104 Views

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Chapter 10

Reporting and Interpreting Bonds

ANSWERS TO QUESTIONS

1.        A company might choose to issue bonds instead of stock to avoid diluting shareholders’ interests, to benefit from the tax deductions associated with paying interest, and to potentially increase the return to shareholders.

2.        A bond is a liability that is issued to the investing public to raise capital. Bonds are traded on established exchanges, such as the New York Bond Exchange. When a company issues bonds, it receives money from investors. Investors pay for the bonds in order to earn interest over the life of the bond. At the end of a bond’s life, investors receive the bond principle amount back from the company.

3.        Unsecured bonds are not backed by any type of asset as a guarantee of repayment at maturity. Secured bonds are backed by specific assets as a guarantee of repayment at maturity.

4.        A bond indenture is a legal document that specifies all the details of a bond offering. A prospectus is a regulatory document filed with the Security and Exchange Commission. It also provides details of the bond offering. A bond indenture and a bond prospectus provide similar information.

5.        Bond covenants are designed to protect bond investors but limiting what a company can do while the bond is still outstanding.

        


6.        A bond’s coupon rate (also called the stated rate, contract rate, or nominal rate) is the interest rate specified on a bond and is the rate used to compute the bond’s periodic cash interest payment. The market rate of interest (also known as the yield or effective interest rate) is the rate of return investors demand for a company’s bonds on the date the bonds are issued. Any difference between a bond’s coupon rate and the market rate of interest on the date of issuance creates a bond discount or a bond premium depending on whether the coupon rate is lower or higher than the market rate.

7.        The difference between a bond’s coupon rate and the market rate of interest determines whether a bond is issued at a discount or a premium. When the coupon rate is lower than the market rate of interest, the bond is issued at a discount. When the coupon rate is higher than the market rate of interest, the bond is issued at a premium.  

8.        The market interest rate reflects the return investor demand to invest in a security with a given level of risk, so it is the rate used to discount a bond’s future cash flows when calculating a bond’s present value.

9.        The book value of a bond is the bond’s principle amount plus any premium or minus any discount. A bond’s book value is what a company reports on its balance sheet.

10.        The formula used to calculate the cash payment bond investors receive for interest each period is: principle amount x coupon rate. The formula used to calculate interest expense reported each period is: book value of the bond at the beginning of the period x the market rate of interest on the date of issuance.

11.  The debt-to-equity ratio is calculated by dividing total liabilities by total stockholders’ equity. The ratio describes the relationship between the amount of capital provided by owners and the amount of capital provided by creditors.

12.        When market interest rates increase, bond prices decrease. This concept is easily understood by remembering that the market rate of interest is the discount rate used to calculate the present value of a bond’s future cash flows. The higher the discount rate the lower the present value of the bond.

ANSWERS TO MULTIPLE CHOICE

  1. c)
  1. c)
  1. b)
  1. d)
  1. c)
  1. b)
  1. c)
  1. c)
  1. a)
  1. c)


Authors’ Recommended Solution Time

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*  Due to the nature of this project, it is very difficult to estimate the amount of time students will need to complete the assignment.  As with any open-ended project, it is possible for students to devote a large amount of time to these assignments.  While students often benefit from the extra effort, we find that some become frustrated by the perceived difficulty of the task.  You can reduce student frustration and anxiety by making your expectations clear.  For example, when our goal is to sharpen research skills, we devote class time to discussing research strategies.  When we want the students to focus on a real accounting issue, we offer suggestions about possible companies or industries.

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