Zero coupon bond amortization schedule


  1. Zero-Coupon Bond
  2. Zero Coupon Bond Value
  3. How to Amortize Imputed Interest |
  4. Example of Zero Coupon Bond Formula with Rate Changes

In a formula, [4]. In loans that allow prepayment , the WAL cannot be computed from the amortization schedule alone; one must also make assumptions about the prepayment and default behavior, and the quoted WAL will be an estimate. The WAL is usually computed from a single cash-flow sequence. Occasionally, a simulated average life may be computed from multiple cash-flow scenarios, such as those from an option-adjusted spread model. WAL is a measure that can be useful in credit risk analysis on fixed income securities, bearing in mind that the main credit risk of a loan is the risk of loss of principal.

All else equal, a bond with principal outstanding longer i. In particular, WAL is often used as the basis for yield comparisons in I-spread calculations.

Zero-Coupon Bond

WAL should not be used to estimate a bond's price-sensitivity to interest-rate fluctuations, as WAL includes only the principal cash flows, omitting the interest payments. Instead, one should use bond duration , which incorporates all the cash flows. The WAL of a bullet loan non-amortizing is exactly the tenor, as the principal is repaid precisely at maturity. How is the price to be paid for a bond determined after an effective rate of interest has been established?

Answer: Determination of the price of a bond is a present value computation in the same manner as that demonstrated previously in the coverage of intangible assets. The parties have negotiated an annual 6 percent effective interest rate.

Zero Coupon Bond Value

In a present value computation, total interest at the designated rate is calculated and subtracted to leave the present value amount. That is the price of the bond, often referred to as the principal. Interest is computed at 6 percent for two years and removed. The remainder is the amount paid for the bond. This can be found by table, by formula, or by use of an Excel spreadsheet. Here, i is 0. Present value can also be determined using an Excel spreadsheet.

Bond prices are often stated as a percentage of face value. The price is the future cash payments with the negotiated rate of interest removed.

How to Amortize Imputed Interest |

The issuance is recorded through the following entry. The entry shown here can also be recorded in a slightly different manner. The discount serves as a contra account to reduce the net liability balance to its principal amount. Figure As shown in the above journal entry, the bond is initially recorded at this principal amount.

Subsequently, two problems must be addressed by the accountant. The additional payment is the cost of the debt, the interest. To arrive at fairly presented figures, these two problems must be resolved. How is a zero-coupon bond reported in the period after its issuance? It solves both of the accounting problems mentioned here. The debt balance is raised gradually to the face value and interest of 6 percent is reported each year over the entire period. However, no payment is made. Thus, this interest is compounded—added to the principal. Interest that is recognized but not paid at that time must be compounded.

The contra account is reduced so the net liability balance increases. Thus, overall reporting of the interest and the liability is not impacted by the method used in recording the issuance of the bond. The balances to be reported in the financial statements at the end of Year One are as follows:. The principal is higher in this second year because of the compounding addition of the first year interest.

If the principal increases, subsequent interest must also go up. That was exactly 6 percent of the principal in each of the two years. Total interest reported for this zero-coupon bond is equal to the difference between the amount received by the debtor and the face value repaid.

How to Amortize a Bond Discount

Both of the accounting problems have been resolved through use of the effective rate method. If interest is then recognized each period based on this same set of variables, the resulting numbers will reconcile. Question: This bond was sold at the present value of its future cash flows based on a rate of interest negotiated by the parties involved. Interest was then recognized periodically by applying the effective rate method. Is the effective rate method the only acceptable technique that can be used to compute and report interest when the face value of a debt differs from its issue price? Answer: Interest can also be calculated for reporting purposes by a simpler approach known as the straight-line method. Using this technique, an equal amount of the discount is assigned to interest each period over the life of the bond.

Example of Zero Coupon Bond Formula with Rate Changes

Payment will be made in two years. However, a question should be raised as to whether the information reported under this method is a fairly presented portrait of the events that took place. Although the bond was sold to earn 6 percent annual interest, this rate is not reported for either period. In reality, the parties established an annual rate of 6 percent for the entire two-year period.