A company has majority fixed rate debt. If interest rates decrease, the fair value of the companies debt goes up. But the accounting cost associated with this rise is 0 becasue the rate is fixed, yet there is still an economic cost. My question is, does this rise in the fair value of the debt result in higher liabilities on the books or do the liabilities get marked at cost
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We are (were?) seeing this scenario play out in the HY bond market. It doesn't matter what the market value (ie what the bonds are trading at) what gets marked on the balance sheet is the actual obligation outstanding (par * number of bonds).
^^^Correct. BV is on the balance sheet, not MV.
When debt prices rise/fall significantly since the debt was issued firms can buy back their debt at market cost and issue the same par value at market to record gains and losses in their books. While no eonomic change has happened, it is one of those loopholes where a firms management can inflate/deflate their numbers. One of the (few) things I remember from Intermediate II.
No. Lets go back to the bond example. A tender offer (ie what you describe above) is done at a PREMIUM. Second, please explain how you can just magically re-issue at par?
I believe he was talking about rates rising, companies buying back the debt and issuing new debt with the higher coupon payment thus locking in a book gain of 100-(Price of debt in secondary market + issuing fees). While this technically works, I'm not sure how smart it would be to issue debt at a higher interest rate--maybe if the company is trying to an achieve optimal capital structure? but I'm not in banking so I really don't know.
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