A-Level Question & Answer On Finance For Free Use

(a)Discuss the conceptual merit(s) of each of the date-of-issue balance sheet presentations shown above for these bonds.
(b)Explain why investors would pay $1,085,800 for bonds that have a maturity value of only $1,000,000.
The difference between the present value and the maturity value of the bond depends on the interest rate and the coupon rate. If the coupon rate of a bond is greater than the yield to maturity rate, then it will trade at a premium to its face value. Therefore, it is clear that the bonds of Nicholas company are presently trading at premium to its face value and the investors interested to purchase the bonds should pay premium.
(c)Assuming that a discount rate is needed to compute the carrying value of the obligations arising from a bond issue at any date during the life of the bonds, discuss the conceptual merit(s) of using for this purpose:
(1)The coupon or nominal rate:
Coupon or nominal rate is the stated rate interest of the bond and is quoted in percentage to the face value of the bond. Using the coupon rate as the discount rate offers simplicity to the bond valuation exercise as other discount rate involves a high level of subjectivity.
(2)The effective or yield rate at date of issue
Since the bonds are traded in the secondary market, they are mostly traded at a value below or above their face value and thus yield interest rate that is different from the nominal yield rate. Therefore, discounting bond cash flows with the effective yield rate is the appropriate discount multiple as it represent the risk involved with cash flows of the bond
(d)If the obligations arising from these bonds are to be carried at their present value computed by means of the current market rate of interest, how would the bond valuation at dates subsequent to the date of issue be affected by an increase or a decrease in the market rate of interest?
Important to note, interest rate and bond value carry an inverse relationship. For instance, if the interest rate increases, in that case, the value of the bond will decrease and in case the interest rate decreases, the value of the bond will increase.