Question

1: The monthly payment on a 900,000 , 20 yr. mortgage at 5.75% is $6,318.75 per month. How much of that 900,000 on day 1 is deemed to be "current portion of mortgage payable"?

2: Explain the difference between straight-line method of amortization a bond discount as opposed to using the effective interest method of amortizing a bond discount.

3: Why does a Bond sell at a discount? Why would a Bond sell at a premium?

Answer 1

	Amount of mortgage	$900,000
	Monthly interest rate	0.479167%	(5.75/12)	0.479167
	Number of Months	240	(20*12)
	Monthly payment	$6,318.75	(Using PMT function withRate=0.479167%,Nper=240,PV=-900000)
	N	P
	Month	Principle	(Using PPMT Function of excel with Rate=0.479167%,Per=N,Nper=240, PV=-900000
		Payment
	1	$2,006.25
	2	$2,015.86
	3	$2,025.52
	4	$2,035.23
	5	$2,044.98
	6	$2,054.78
	7	$2,064.63
	8	$2,074.52
	9	$2,084.46
	10	$2,094.45
	11	$2,104.48
	12	$2,114.57
	SUM	$24,719.73
	Current Portion=Payment of principle in next 12 months
	Current portion of Mortgage Payable on Day1	$24,719.73
2	In Straight line method, the Bond Discount is
	Amortised over the life of the bond in equal
	amount per period.
	Example:
	Face Value=$100,000
	Annual Coupon payment =9%
	Maturity =10 years
	Market return=10%
	Bond is sold at $93845
	Discount amount=(100000-93845)=	$         6,155
	Amortization per period=6155/10=$615.50
	Coupon payment at the end of year=	$9,000	(0.09*100000)
	Journal entry for discount amortization in year 1
	Debit : Interest expense	$   9,615.50
	Credit : Discount	$       615.50
	Credit: Cash	$9,000
	Every year $615.50 will be credited to discount account
	Interest expense will be $9,615 every year
	Interest expense and discounts are constant
	Effective Interest Method:
	Under this method, the interest expense is recorded as Market interest rate Times the Carrying amount in the beginning of year
	Interest expense=Interest for the period at market rate
	Carrying amount at the beginning of year 1	$93,845
	Interest expense in year 1	$9,384.50	(93845*0.1)
	Interest paid	$9,000
	Amortization of discount	$384.50	(9384.50-9000)
	Journal entry for discount amortization in year 1
	Debit : Interest expense	$9,384.50
	Credit : Discount	$384.50
	Credit: Cash	$9,000
	Interest expense will increase every year as the carrying amount increases
	Amortization will also increase every year
3	The Price of a Bond at a given time is the Sum of Present value of all future cash flows discounted at market rate
	If the market rate is same as the coupon rate, the Bond Price will be same as Face Value
	If the market rate is higher than the coupon rate,the present value of cash flow discounted at market rate
	Will be lower than face value
	Hence bBond will Sell at discount
	If market rate is lower than the coupon rate , the Present value of Cash flows will be higher than face value
	The Bond price will be higher than face value
	Bond will sell at Premium