Question

In: Accounting

Discussion Question #1 Refer to the article “Rising Interest Rates Trigger Losses on Banks Massive Bond...

Discussion Question #1 Refer to the article “Rising Interest Rates Trigger Losses on Banks Massive Bond Holdings” in Wall Street Journal (December 7, 2016) What is the difference between realized and unrealized gains and losses on security holdings? What are the three categories of investments identified in authoritative accounting literature? Cite the authoritative guidance you are referencing. What is the difference in accounting treatment of unrealized gains and losses across these three categories of investments? Cite the authoritative guidance you are referencing. Why do unrealized losses affect a bank's book value but “don't immediately diminish a banks profits”? In your answer, define the “special bucket...called 'accumulated other comprehensive income.'”

Solutions

Expert Solution

DIFFERENCE BETWEEN REALIZED AND UNREALIZED GAINS AND LOSSES OF SECURITY HOLDING:

  • A realized capital gain or loss is reflected as Realized gain /loss but an Unrealized gain or loss is a increase or decrease in the value of a security that has not been sold.
  • Realized gain or loss refer to profit and losses from a complete transaction whereas unrealized gain or loss refer to profit and loss that have occurred on paper, but the relevant transactions have not been completed. (so unrealized gains or loss is called as Paper Profit or loss)
  • Realized gain or loss is the actual result resulted from selling the holdings in a particular investment. Unrealized gain or loss is the book value of such investment on particular date.
  • Realized profits can be converted into cash.

3 CATEGORIES OF INVESTMENT:

There are 3 main types of investment, namely

  • Stock
  • bonds
  • cash equivalents

Another option to invest in is tax deferred options such as IRA or annuity.

STOCKS:

  • When you buy shares of a company's stock, we own a piece of that company. Stocks come in a wide variety, they often described based on the company's size,type, performance during market period cycles and potential for short term and long term growth.
  • Companies sells stock of shares to raise money for start up or growth.
  • When we buy, we are the shareholder of that company.
  • There are 2 types of stock,

COMMON STOCK : Shareholders have a percentage of ownership,have a right to vote on issues effecting the company and receive dividends.

PREFERRED STOCK: Shareholders generally receive dividends on specific intervals and in predetermined amounts but dot have voting right.

BONDS:

  • Bonds are considered a more stable investment compared to stocks as there is a steady flow of income.
  • A bond is loan an investor makes to n organisation in exchange of interest payments over a specified term plus repayment of principal amount at its maturity date.
  • It subject to a number of risks like credit risk, repayment risk, interest rate risk.

CASH EQUIVALENTS:

Cash equivalent investment protect our original investment and lets us to have access to our money

examples are Saving accounts

money market accounts

certificate of deposit (COD)

ACCOUNTING TREATMENT OF UNREALIZED GAINS OR LOSSES OVER THESE 3 TYPES OF INVESTMENTS:

The treatment for unrealized gains \ losses depends upon whether securities are classified as held to security, trading, available to sale.

If they are classified as held to security, they are not recognized in the financial statements.

If investments classified as trading securities then they are recognized in the financial statements. at fair value in the net income even though securities have not been sold.

if investment classified as available for sale, they were also reported in financial statements at fair value in the assets side of the balance sheet.

Unrealized losses doesn't effect the bank value as it doesn't show any impact on cash flow statement.

DEFINITION OF SPECIAL BUCKET CALLED ACCUMULATED OTHER COMPREHENSIVE INCOME:

These are the expenses, gains and losses reported in the equity section i.e shareholders equity of the balance sheet. It includes unrealized gains and losses on certain type of investments, as well as on pension funds and other foreign currency transactions.


Related Solutions

Consider a 5-year bond with a 6 1/2% coupon interest rate. If interest rates are rising,...
Consider a 5-year bond with a 6 1/2% coupon interest rate. If interest rates are rising, we would expect the price of the bond to:
And then there is the issue of the dividend yield: if interest rates are rising, then...
And then there is the issue of the dividend yield: if interest rates are rising, then the preferred stock becomes less valuable and trades at a lower price. And preferred stock is usually more expensive to purchase than common stock anyway. If you were to purchase a business’ stock, would you purchase preferred stock because of the dividend preference, or common stock?
1. Interest rates can fall to zero, but this does not mean that banks will be...
1. Interest rates can fall to zero, but this does not mean that banks will be able to lend out more money. True / False 2. The president of the New York Federal Reserve Bank serves as a permanent member of the Open Market Committee. True / False 3.After being without a central bank from 1833 to 1913, Congress passed the Federal Reserve Act which established our present central bank. true / false 4. Which of the following is a...
Interest rates are important to financial institutions, like banks, since an increase in interest rates ________...
Interest rates are important to financial institutions, like banks, since an increase in interest rates ________ the cost of acquiring funds and ________ the income from financial assets. A. decreases; decreases B. increases; increases C. decreases; increases D. increases; decreases (I) Debt markets are often referred to generically and collectively as the bond market. (II) A bond is a security that is a claim on the residual earnings and assets of a corporation after contractual payments are made to stockholders....
Question 1. (Interest Rates and Bond Valuation) (1) Find out values of following bonds. YTM is...
Question 1. (Interest Rates and Bond Valuation) (1) Find out values of following bonds. YTM is 7%, and Time to maturity is 10 years Bond A: 3.5% of coupon paid semiannually, Face value = $1,000,000 Bond B: 0% of coupon, Face value = $5,000,000 Bond C: 10% of coupon paid annually, Face value = $3,500,000 (2) Suppose you will receive money of $ 20,000 worth of purchasing power for 5 years. The first payment will be given at the end...
1. At the beginning of the COVID-19 pandemic, interest rates declined at the central banks but...
1. At the beginning of the COVID-19 pandemic, interest rates declined at the central banks but one bank did not pass on the decrease to borrowers citing funding difficulty and shareholder returns as the main reasons. It turns out the CEO of that bank owns 5% of the shares of the bank. Do you think there is an ethical issue surrounding this decision? What might change the CEO’s mind? (200 words)
Banks sometimes quote interest rates in the form of “add-on interest.” In this case, if a...
Banks sometimes quote interest rates in the form of “add-on interest.” In this case, if a 1-year loan is quoted with an interest rate of 14.5% and you borrow $1,000, then you pay back $1,116. But you make these payments in monthly installments of $93 each. a. What is the true APR on this loan? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places. Use a financial calculator or Excel.) b. What is...
Which answer is TRUE regarding bond prices and interest rates? Bond prices and interest rates move...
Which answer is TRUE regarding bond prices and interest rates? Bond prices and interest rates move in opposite directions. Interest rate risk is the risk that a company will default on its interest payments. The prices of short-term bonds display greater price sensitivity to interest rate changes than do the prices of long-term bonds. The price of a bond is the future value of the coupon payment and the face value.
QUESTION 2 Select any TWO commercial banks in Malaysia. Based on the saving account interest rates...
QUESTION 2 Select any TWO commercial banks in Malaysia. Based on the saving account interest rates offered by the banks, calculate the future value of annuity of RM300,000 made at the beginning of every year for 10 years. Analyse and compare the effect of the interest rates offered by the banks on the total savings. ASSIGNMENT RUBRICS Criteria Excellent Good Fair Poor Unsatisfactory Max Marks 4 3 2 1 0 Introduction of the selected commercial banks. Clear and detailed introduction...
Interest rates and bond prices, move inversely. For example, when interest rates decline, bond prices increase;...
Interest rates and bond prices, move inversely. For example, when interest rates decline, bond prices increase; when interest rates increase, bond prices decrease. Provide a quantitative example, illustrating the effect of interest rates on bond pricing? As well, explain how the length of bond maturity and higher/lower coupon rates can affect bond prices when interest rates rise and fall in the economy.
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT