Part 1: Briefly explain a bond contract and its relationship to cash flows. Part 2: Define the following terminology with respect to bonds:

Question

a. Face Value
b. Principal
c. Maturity Value
d. Market Value
e. Coupon Interest Rate
f. Historical Market Interest Rate or Initial Yield to Maturity
g. Current Market Interest Rate

Answer 1

REVIEW OF BOND TERMINOLOGY

1 . The bond contract specifies the basis for computing all future cash flows for that bond issue. Identifying those cash flows is the starting point to account for the bond both initially and at each subsequent measurement date.

2 . Terminology with respect to bonds includes the following:

a. Face Value: The amount printed on the face of the bond certificate that serves as the basis for computing periodic coupon payments on coupon bonds. The face value equals the maturity value on coupon bonds and on zero coupon bonds but not on serial bonds.

b. Principal: The same as face value on coupon bonds and serial bonds but not on zero coupon bonds.

c. Maturity Value: The amount paid by the issuer at the maturity date of bonds. The maturity value equals the face value on coupon bonds and on zero coupon bonds.

d. Market Value: The amount at which bonds sell in the market either at date of issue or at any subsequent date while the bonds are outstanding. Firms that account for bonds using the fair value option can use market value to measure fair value.

e. Coupon Interest Rate: The interest rate stated in the bond contract that when multiplied times the face value or principal amount of coupon bonds equals the required annual cash payment. The stated coupon rate is always an annual rate. The issuer might pay this required annual amount in more than one installment during the year, typically semiannually. The frequency of payment affects the yield on the bond and the amortization calculations. The coupon rate need not equal the historical market interest rate.

f. Historical Market Interest Rate or Initial Yield to Maturity: The interest rate that discounts all future cash flows such that their present value equals the initial issue price of the bond.

g. Current Market Interest Rate: The interest rate that discounts all future cash flows such that their present value equals the current market price of the bond.