BONDSL-TNOTES-UniversityofWashington.docVIP

BONDS L-T NOTES The PV of a liability is the PV of its related cash flows discounted at the effective rate of interest at time of issue. Here is where you get to use the stuff you learned in chapter 6! A bond’s selling price and, therefore, carrying value at time of issue depends on the effective rate that the market demands at time of issue. The effective rate is the sum of the: 1 risk free rate + 2 a risk premium + 3 inflation rate. The higher the effective rate, the lower the selling price. Terms to know: Principal, par value, face amount, maturity value all the same . Maturity date 10 – 30 years for bonds, typically shorter for notes . Interest: 1 stated rate, coupon rate, nominal rate—in bond agreement—the amount that will be paid cash flow ; 2 effective rate used to calculate interest expense/revenue . Bonds have various degrees of backing and therefore risk. Senior bonds have lower effective interest than subordinated bonds. Secured debt has lower risk than unsecured. Junk bonds frequently issued to finance LBOs are unsecured and risky. Callable bonds give the issuer the option to retire the bonds early. These sell for less than if they were not callable. Registered bonds: in name of investor, transfer is formal. Coupon bonds and bearer bonds: not recorded in name of investor, transfer by means of possession. Convertible bonds—conversion option has value, but currently we account for these bonds in the same way that we do nonconvertibles except at time of conversion . Home Depot has issued $billions of these in the past. Income bonds only pay interest if company has income. Revenue bonds are usually issued by government bodies and pay interest out of specific revenue sources. GO bonds issued by Washington State. “Munis” have tax avantages. Exotic bonds: e.g., Weather Bonds—hedge against heating oil prices.Accounting for Bonds at time of issuance Depends on whether the bonds are sold at par, above par premium , or below par discoun