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

1) Amount of Mortgage                                                = 900,000

Monthly Rate of Coupon                              = 5.75/12 = 0.48% (0.479167%)

Number of months of Mortgage                               = 240

Monthly Payments                                         = 6318.75

Current portion of mortgage payable on day 1 = payment of principle in next 12 months

Payment of principle in next 12 months is calculated using the following excel formula :

PPMT where Rate = 0.479167%, Per=N, Nper= 240, PV= -900,000

Payment	Month
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

2) Under Straight Line Method, the bond discount is amortized over life of the bond in equal installments.

Herein, interest expenses are constant every accounting year until bond matures

Under Effective interest method, the interest expense is recorded as Market Interest Rate multiplied by carrying amount at the beginning of the year.

Under this method, interest expense tends to increase every accounting year until bond matures

3) The market price of a bond is the sum of present value of all future cash flows discounted at the prevailing market rates.

If market rate of interest is higher than coupon rate, the bond will sell at discount since PV of cash flows shall be lower than face value

If market rate of interest is lower than coupon rate, the bond will sell at premium since PV of cash flows shall be higher than face value