Unformatted text preview:

ACG 3171 Final Exam Study GuideAnalysis of Financial Statement PresentationsProfessor GilliamChapter 111. Bond Basicsa. Principal amount = par value = maturity value = face valueb. Stated interest rate = coupon rate = nominal ratec. Cash interest = principal * stated interest rated. Face value typically $1,000, but the PRICE of the bond can and will differi. Bonds can sell at face value, with discounts, or at premiums ii. Par: Issue price = face valueiii. Discount: Issue price < face value (interest rates are up)iv. Premium: Issue price > face value (interest rates are down)e. The issue price and the stated interest rate are used to determine the “effective yield” – the true rate of returnf. When a bond is sold at par, its effective yield is the stated rateg. The market for bonds that lack active trading can have large differences between retail and wholesale prices (& unlisted pricing) 2. Example: Bonds payablea. OPM issues bonds with a total face value of $1,000,000 and 10% interest at par or face value (no discount or premium). b. This transaction is simply an exchange of a liability for cash plus an on-going interest expense.i. OPM’s initial journal entry:DR Cash $1,000,000CR Bonds Payable $1,000,000Annual interest payment:DR Accrued interest payable $100,000CR Cash $100,000c. Example 2: If the rates rise, and the bond is issued at a Discounti. OPM issues bonds with a face value of $1,000,000 at 10% per year when the rates are 11%.ii. The selling price that will yield an 11% return to the bond buyers is $941,108. iii. As with Notes Receivable the bond is recorded at Present Value (PV) – as sellers we will always know this amount because it is the selling price. DR Cash $941,108DR Bond Discount $58,892 (this is the difference between face value and selling price; $1,000,000-$941,108 = $58,892)CR Bonds payable –par $1,000,000How to set up the above journal entry: 1. Start with a DR to Cash, for the selling price of $941,1082. Next CR Bonds Payable (liability) for the face value of $1,000,0003. Last, DR Bond Discounts for the difference (this serves as a contra account)From this point on, you record yearly interest expense:DR Interest expense $103,522 (= $941,108*.11)CR Accrued interest payable$100,000 (this is what you actually owed, = $1,000,000*.10) CR Bond Discount $3,522 (this number is the difference between your interest expense and accrued interest payable; $103,522-$100,000; this reduces the contra account that originally had $58,892)d. Example 3: OPM problem, but rates decline and the bonds are issued at a premiumi. OPM’s accounting entry when their 10% bonds (par $1,000,000) are issued at a price of $1,064,177 that yields 9%, therefore at a premiumDR Cash $1,064,177 (given) CR Bond Premium $64,177 (difference between issued price and par value; $1,064,177-$1,000,000 = $64,177; aka premium) (this serves as a contra account)CR Bonds payable-par $1,000,000To record subsequent interest expense:DR Interest expense $95,776 ($1,064,177 * .09)DR Bond Premium $4,224 (you get this number by subtracting your actual interest expense (i.e. $1,064,177 * .09 = $95,776) from what your interest expense would be at par (i.e. $1,000,000 * .10 = $100,000) (i.e., $100,000-$95,776 = $4,224) (this number gets subtracted from the original contra account of $64,177)CR Accrued interest payable$100,000 (the accrued interest payable will always be from the original par value number, i.e. $1,000,000 * .10 = $100,000)3. Basic types of derivative instrumentsa. Forward contract : Two parties agree to a sale on future (settlement) date at a specified pricei. Two parties agree to the sale of some asset on some future date (settlement date) at a price specified today:1. Ex: you order a laptop online and the final price is $1,000, when the laptop arrives, you pay the predetermined price of $1,000 and take delivery2. Three elements of the contract are key:a. The agreed upon price to be paid in the futureb. The delivery datec. The buyer will actually “take delivery”b. Futures contract : Variation of forward contract; traded daily in financial exchange market; no specified settlement datei. Two parties agree to the sale of some asset on some indefinite future date at a price specified today:1. On October 5th, one side of the party, sells a February cotton contract to LS&Co for 10 million pounds at $0.95 per pound. Anytime in February, LS&Co pays $0.95 per pound and takes delivery from seller.2. Futures contracts are like forward contracts except:a. They do not have a predetermined settlement dateb. They are actively traded on financial exchange3. Settlement can occur through delivery or by creating a “zero net position”. Which means you buy an offsetting contract, with the like terms. 4. Benefits to the seller:a. Delivery price is locked in, does not have to worry about “market risks”b. Cash receipts are predictable, not subject to market fluctuations.c. Futures contracts are used a lot with agricultural product. Farmers plan months ahead of time, what crop they want to plant and harvest. The farmers want to lock in a price, say for wheat, maybe 1,000lbs at $2.00/lb, to ensure that they are able to make a profit. If the farmers didn’t have the futures market, they could possible decide to plant wheat and harvest and grow it and when they go to sell it in the future, the price could have dropped, resulting in them not making any profit for the wheat they spent 6 months growing.5. Benefits to the buyer:a. Delivery price is locked in, does not have to worry about “market risks”b. The buyer is hoping to make a profit off the futures contract as well. They are guessing that the price of wheat will be more expensive then the agreed upon $2.00/lb,when the delivery time comes 6 months in the future. If the actual price of wheat 6 months into the future is $2.20/lb, then the buyer of the futures contract just made $0.20/lb, times the agreed 1,000 lbs they purchased. He makes this profit, because he agreed to pay $2.00/lb and that’s what he will pay, then he will immediately sell the 1,000 lbs of wheat for the current price of $2.20/lb. The farmer could have made $0.20/lb more if he never entered a futures contract, but that’s the cost of the insurance to make a guaranteed $2.00/lb. 6. The futures contracts eliminate both downside risk and upside potential. c. Swap contract : one stream of future interest payments exchanged

View Full Document

FSU ACG 3171 - Final Exam Study Guide

Download Final Exam Study Guide
Our administrator received your request to download this document. We will send you the file to your email shortly.
Loading Unlocking...

Join to view Final Exam Study Guide and access 3M+ class-specific study document.

We will never post anything without your permission.
Don't have an account?
Sign Up

Join to view Final Exam Study Guide 2 2 and access 3M+ class-specific study document.


By creating an account you agree to our Privacy Policy and Terms Of Use

Already a member?