Question

On January 1 of Year 1, Lily Company issued bonds with a coupon rate of 7% and a face amount of $3,000. The bond interest payments are made twice each year on June 30 and on December 31. The bonds mature in 12 years. The market interest rate for bonds with the same degree of riskiness is 10% compounded semi-annually. On January 1 of Year 1,Investor Company purchased all of the Lily Company bonds when they were issued. Investor Company has classified this investment in bonds as a held-to-maturity investment. What is the total amount of interest revenue that Investor Company will report in Year 1 in connection with this bond investment? Of course, Investor Company uses the effective interest amortization method. Note: Round all of your calculations to the nearest penny.

	$237.90
	$28.60
	$620.94
	$62.09
	$210.00
	$238.60

Answer 1

	CALCULATION OF PRESENT VALUE OF THE BOND IF THE INTEREST PAID SEMI ANNUALLY
	Step 1 : Calculation of Annual Coupon Payments
	Par value of the bond issued is   =			$3,000	Million
	Annual Coupon %			7.00%
	Annual Coupon Amount			$210.00	Million
	Semi Annual Coupon Amount			$105.00	Million
	Step 2: Calculate number of years to Maturity
	Number of years to maturity = 12 years
	Interest is paid semi annyally so total period = 12 Years * 2 = 24 Periods
	Step 3 : Caclulation of Current Market Price (intrinsic value) of the bonds
	Market rate of interest or Yield to Maturity or Required Return = 10%
	Bonds interest is paid semi annualy means so discounting factor = 10 % /2= 5 %
	PVF = 1 / Discount rate = 1/ 1.05
	Result of above will again divide by 1.05 , repeat this lat period
	Period	Interest	Amount (In Million)	PVF @ 5%	PresentValue
	1	Interest	$105.00	0.9524	$100.00
	2	Interest	$105.00	0.9070	$95.24
	3	Interest	$105.00	0.8638	$90.70
	4	Interest	$105.00	0.8227	$86.38
	5	Interest	$105.00	0.7835	$82.27
	6	Interest	$105.00	0.7462	$78.35
	7	Interest	$105.00	0.7107	$74.62
	8	Interest	$105.00	0.6768	$71.07
	9	Interest	$105.00	0.6446	$67.68
	10	Interest	$105.00	0.6139	$64.46
	11	Interest	$105.00	0.5847	$61.39
	12	Interest	$105.00	0.5568	$58.47
	13	Interest	$105.00	0.5303	$55.68
	14	Interest	$105.00	0.5051	$53.03
	15	Interest	$105.00	0.4810	$50.51
	16	Interest	$105.00	0.4581	$48.10
	17	Interest	$105.00	0.4363	$45.81
	18	Interest	$105.00	0.4155	$43.63
	19	Interest	$105.00	0.3957	$41.55
	20	Interest	$105.00	0.3769	$39.57
	21	Interest	$105.00	0.3589	$37.69
	22	Interest	$105.00	0.3418	$35.89
	23	Interest	$105.00	0.3256	$34.18
	24	Interest	$105.00	0.3101	$32.56
	24	Bond Principal Value	$3,000.00	0.3101	$930.20
		Total			$2,379.06
		Current Bonds Price =			$2,379.06
	Issue price of the bond=			$2,379.06
	Par Value of the bonds =			$3,000.00
	Discount to be amortized =			-$620.94
	Working notes
	EFFECTIVE - INTEREST AMORTIZATION SCHEDULE
	MARKET RATE OF INTEREST IS 10% AND BOND INTEREST IS 7%
	Date	Interest payment on face value	Interest Expenses (Cash paid - Decrease in Carrying value)	Amortization expenses	Credit Balance in bond discount	Credit Balance in acct payable	book Value of the bond
	1/1	$                                                                             -	$                                    -	$                          -	$           -620.94	$                3,000	$          2,379.06
1	06/30	$                                                                          105	$                           118.95	$                   13.95	$           -606.99	$                3,000	$          2,393.01
2	12/31	$                                                                          105	$                           119.65	$                   14.65	$           -621.64	$                3,000	$          2,407.66
		Interest Expenses :
		For Coupon Received of June Ended =	$                                 105
		For Coupon Received of Dec Ended =	$                                 105
		Add: Interest Amortization (Periof 1+2)	$                             28.60
		($ 13.95 + $ 14.65)
		Total Revenue =	$                           238.60
		Answer = Option 6 = $ 238.60