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Bond Effective Interest Rate Calculation

The document outlines the calculation of the initial carrying amount of a bond, which totals 1,070 after including transaction costs. It details the process of determining the effective interest rate through trial and error, concluding with an effective rate of 6.81%. An amortization table is provided, showing interest income and amortization over five years for the bond issued at 900 with a mandatory redemption of 1,100.

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DERYL GALVE
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7 views2 pages

Bond Effective Interest Rate Calculation

The document outlines the calculation of the initial carrying amount of a bond, which totals 1,070 after including transaction costs. It details the process of determining the effective interest rate through trial and error, concluding with an effective rate of 6.81%. An amortization table is provided, showing interest income and amortization over five years for the bond issued at 900 with a mandatory redemption of 1,100.

Uploaded by

DERYL GALVE
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd

Solutions:

The initial carrying amount of the bond is determined as follows:


Acquisition cost       1,000
Transaction costs           70
Initial measurement       1,070

The effective interest rate is determined using the “trial and error approach” with interpolation when necessary.
Future cash flows x PF @X% n = Present value (initial carrying amount)
Where: X% = effective interest rate

First trial: @6%


 (1,200 x PV of 1 @6%, n=5) + (50 x PV ordinary annuity of 1 @6%, n=5) = 1,070
 (1,200 x  0.747258) + (50 x 4.212364) = 1,070
 897 + 211 = 1,108 is not equal to 1,070

Second trial: @7% (we need a lower amount so we’ll increase the rate)
 (1,200 x PV of 1 @7%, n=5) + (50 x PV ordinary annuity of 1 @7%, n=5) = 850
 (1,200 x  0.712986) + (50 x 4.100197) = 1,070
 856 + 205 = 1,061 is not equal to 1,070
 
From the above computations, we can infer that the effective interest rate is a rate between 9% and 10%. We’ll
perform interpolation next.
x% - 6%
7% - 6%

1,10
1,070 - 8
=
1,10
1,061 - 8 0.81

Effective interest rate (x%) = 6% + .81% = 6.81%

The amortization table using 6.81% as the effective interest is prepared as follows:
Date Payments Int. income Amortization Present value
1/1/x0     1,070
12/31/
x0           50           73           23     1,093
12/31/
x1           50           74           24     1,117
12/31/
x2           50           76           26     1,143
12/31/
x3           50           78           28     1,171
12/31/
x4           50           80           30     1,201

Use the following information for the next three questions:


On January 1, 20x0, an entity issues a bond for P900, incurring transaction costs of P50. Interest of P40 is payable annually, in
arrears, over the next five years starting December 31, 20x0. The bond has a mandatory redemption of P1,100 on December 31,
20x4. 

1. A (See solutions below)


2. B (See solutions below)
3. D (See solutions below)

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