Term Bond Valuation Tutorial (Premium Scenario)
As future leaders of both for-profit and not-for-profit organizations, students need to understand time value of money concepts as they apply to alternative ways of raising capital (cash). For example, a for-profit biotech company or nonprofit scientific research entity may need to purchase expensive new equipment without exhausting its cash reserves. One way these organizations may obtain the desired capital financing is through the issuance of bonds. In brief, when organizations sell bonds to investors, they promise to pay back the amount borrowed at some point in time in the future. In addition, the entity may promise to pay a stated rate of interest to the investor at periodic intervals. This problem based tutorial provides students with an opportunity to practice applying time value of money concepts.
- Determine whether the bond will be sold at a premium or discount.
- Calculate the present value of a term bond.
- Account for bonds when they are sold and redeemed at maturity.
- Account for the semi-annual interest payments made by the borrower.
Higher order thinking skills: Analysis and application.
Context for Use
- Basic algebra including manipulating fractions and exponentiation.
- Exposure to time value of money concepts, namely, determining the present value of a lump sum and the present value of an annuity.
- An understanding of the following terms related to long term debt financing: term bonds, principal, discount, premium, par or face value, stated or contractual rate of interest, market rate of interest, maturity date, compounding periods per year, ordinary annuity and straight-line amortization.
- How to record journal entries.
- Familiarity with a financial calculator (TI BAII Plus illustrated), including how to set the decimals stored to 4 positions.
Description and Teaching Materials
- Students will need a financial calculator (BAII+ preferred) or the following two present value tables available from AccountingStudy.com
- Present value of 1 table.
- Present value of an [link ordinary annuity table.
- Term Bond Valuation - Problem Based Tutorial Worksheet (premium scenario). Bond Tutorial Student Worksheet (Microsoft Word 48kB Aug10 10)
- Solution. Bond Tutorial Solution (Microsoft Word 52kB Aug10 10)
Teaching Notes and Tips
- This tutorial uses the straight-line method of amortization in lieu of the effective interest rate method. The straight-line method while used to introduce the concept of amortization in a principles of accounting class does not conform to generally accepted accounting principles (GAAP).
- The extent of the hints provided on the tutorial worksheet can be included or deleted at the instructor's discretion
- Notation used:
- PVIF( i/m,n*m) = Present value interest factor of a lump sum, where i = market rate of interest, n = years to maturity, and m = compounding periods per year.
- PVIFA(i/m,n*m)= Present value interest factor of an annuity, where i = market rate of interest, n = years to maturity, and m = compounding periods per year.
References and Resources
Though difficult to read, the face value of the bond $1,000 and its stated rate of interest is 6% payable semi-annually on the first day of January and July. Its issue date was July 1, 1873. The maturity date cannot be determined. Corporate and bonds issued by non-profit entities today are similar in appearance.