Quick question on Coupon payment
If the bond is trading at a discount or a premium, is the issuer paying the coupon on the instrument’s face value or market value? So say a 5 yr bond of 1000 Is issued at par with a 10% coupon rate. One year later, the bond is trading at 120. Is the coupon payment from the company’s perspective:
A) 1000 * 10%
Or
B) 1000 * 1.2 * 10%
I would imagine that coupon payment should be fixed regardless of price.
Face value.
Don't know why you got MS. Coupon payment is coupon rate * face value.
That's confirmed.
As per my original post, I am inclined to agree with Prospect above. But anyone who thinks differently?
Just to expand a bit, the actual cash coupon payment is always face value*coupon rate. However, the interest expense that the company records for accounting purposes depends on the effective (market) interest rate at the time of issuance. In this case, since the bond was issued at par, cash payments=interest expense, but if it was issued at a discount for example then the interest expense on the books would be higher than the cash payments.
Thanks. If it was issued at a discount, how would the interest expense be lower than the cash payment???
If the bond is at a discount, interest expense is higher than interest payable because you are amortizing the discount over the life of the bond. Let's say a company takes out a 98k bond with a face value of 100k. This increases cost of borrowing because the company is effectively paying 2k more at maturity. If a bond trades at par, the face value is the same as the company's initial proceeds. This 2k differential I noted is a discount on bonds payable because the company receives less proceeds than the face value.
It occurs when the market rate for similar bonds is higher than the contractual rate(coupon rate). Lower contractual rate than what could be received for similar risk bonds drives down demand, which effectively lowers price of the bond. Of course this ends up driving up the yield on the bond as price is inversely related. The lower price is once again reflected in the lower proceeds the company receives compared to face value.
In accounting, for the example I initially noted, we would debit cash for 98k and a discount on bonds payable for 2k. We would credit bonds payable for 100k. Over the life of the bond, this discount needs to be amortized all the way to 0. To amortize it, you would need to credit the discount. During interest payment entries, we debit interest expense, credit the discount, and credit interest payable(or cash). Therefore, interest expense is going to be greater than the interest payments being paid out. This is of course only for a bond at a discount. For a bond at a premium, it would be the opposite.
Hope this helps
Face value. That’s why companies will sometimes launch open market repurchases of bonds trading at a discount.
Face value. Literally have an exam on this tomorrow.
Although Coupon/Market price = current yield
Update: that exam was an L
F
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