Concept explainers
Kasey Hartman is the controller for Wholemart Company, which has numerous long-term investments in debt securities. Wholemart’s investments are mainly in ?ve-year bonds. Hartman is preparing its year-end ?nancial statements. In accounting for long-term debt securities, she knows that each long-term investment must be designated as a held-to-maturity or an available-for-sale security. Interest rates rose sharply this past year, causing the portfolio’s fair value to substantially decline. The company does not intend to hold the bonds for the entire ?ve years. Hartman also earns a bo-nus each year, which is computed as a percent of net income.
Required
1. Will Hartman’s bonus depend in any way on the classi?cation of the debt securities? Explain.
2. What criteria must Hartman use to classify the securities as held-to-maturity or available-for-sale?
3. Is there likely any company oversight of Hartman's classi?cation of the securities? Explain.
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Chapter 15 Solutions
FUNDAMENTAL ACCT PRIN TEXT+CONNECT CODE
- Energetic Engines is trying to estimate its cost bonds that pay $20 interest every six months. Each bond, which has a $1,000 face value and matures in six years, is currently selling for $900. Estimate Energetic’s cost of retained earnings using the bond-plus-risk-premium approach.arrow_forwardYou are considering an investment In 30-year bonds issued by Moore Corporation. The bonds have no special covenants. The Wall Street Journal reports that 1-year T-bills are currently earning 1.40 percent. Your broker has determined the following Information about economic activity and Moore Corporation bonds: Real risk-free rate = 0.60% Default risk premium = 1.30% Liquidity risk premium = 0.80% Maturity risk premium = 1.90% a. What is the inflation premium? (Round your answer to 2 decimal places.) Expected IP b. What is the fair interest rate on Moore Corporation 30-year bonds? (Round your answer to 2 decimal places.) Fair Interest ratearrow_forwardYour firm is interested in investments and reads in the Treasury Direct that T-Bills are yielding 10%. Your sister, a broker at YXC Securities, advised you to explore either treasury or corporate investments, given the current interest rate premiums. The data she gave is represented in the table : Interest Rates Inflation premium (IP) 6% Maturity risk premium 2% (MRP) Default risk premium for AAA bonds (DRP) Default risk premium for BBB bonds (DRP) Liquidity premium for long-term Treasury bonds (T-bonds) (LP) 3% 4% 1%arrow_forward
- Analysts at New Lenox Securities have reported that the annual interest rate being paid on 3-year bonds issued by the U.S. federal government is 3.3%. The annual rate being paid on 2-year federal government bonds is 3.1%, and the rate being paid on 1-year federal government bonds is 2.8%. Assume also that liquidity and maturity risk premiums are zero (as in the examples we worked). According to the Expectations Theory, what annual interest rate does the market expect the federal government to pay on a 1-year bond originating in year 3? In previous question 9 you were asked to compute a different but related "implied forward interest rate.") O A. 3.70% O B. 330% OC. 3.07% D. 3.40% E. 3.55%arrow_forwardYou are considering an investment in 30-year bonds issued by Moore Corporation. The bonds have no special covenants. The Wall Street Journal reports that 1-year T-bills are currently earning 0.40 percent. Your broker has determined the following information about economic activity and Moore Corporation bonds: Real risk-free rate = 0.33% Default risk premium = 1.55% Liquidity risk premium = 0.90% Maturity risk premium = 1.05% a. What is the inflation premium?b. What is the fair interest rate on Moore Corporation 30-year bonds? (For all requirements, round your answers to 2 decimal places. (e.g., 32.16)) Inflation Premium= % Fair intrest rate= %arrow_forwardYou are considering an investment in 30-year bonds issued by Moore Corporation. The bonds have no special covenants. The wall street journal reports that one-year bonds are currently earning 1.25 percent. Your broker has determined the following information about economic activity and moore corporation bonds: Real risk-free rate = 0.75% Default risk premium = 1.15% Liquidity risk premium = 0.50% Maturity risk premium = 1.75% a. what is the inflation premium? b. what is the fair interest rate on Moore Corporation 30-year bonds?arrow_forward
- You are considering an investment in 30-year bonds issued by Moore Corporation. The bonds have no special covenants. The Wall Street Journal reports that 1-year T-bills are currently earning 1.25 percent. Your broker has determined the following information about economic activity and Moore Corporation bonds: Real risk-free rate = 0.75% Default risk premium = 1.15% Liquidity risk premium = 0.50% Maturity risk premium = 1.75% What is the inflation premium? What is the fair interest rate on Moore Corporation 30-year bonds?arrow_forwardYou are the portfolio manager of a large company that invests in many securities including corporate bonds. Youhave been assigned the task of bond portfolio management. You are provided with the following data in relationto bonds:Maturity period 7 yearsCoupon rate 12%Par value $1,000Coupons on bonds are paid annuallyYield to maturity of bonds 8%Required:i) Calculate the Macualay’s duration, modified duration and convexityii) Calculate the change in bond price when yield to maturity changes by one percent using modifieddurationiii) Calculate the change in bond price when yield to maturity changes by one percent when convexityis consideredarrow_forwardYou are considering an investment in 30-year bonds issued by Moore Corporation. The bonds have no special covenants. The Wall Street Journal reports that 1-year T-bills are currently earning 2.15 percent. Your broker has determined the following information about economic activity and Moore Corporation bonds:Real risk-free rate = 0.75%Default risk premium = 2.05%Liquidity risk premium = 1.40%Maturity risk premium = 2.65% What is the inflation premium? (Round your answer to 2 decimal places.) Expected IP ______.__% What is the fair interest rate on Moore Corporation's 30-year bonds? (Round your answer to 2 decimal places.) Fair Intrest Rate _______.__%arrow_forward
- ABC Co. has a large amount of variable rate financing due in one year. The management is concerned about the possibility of increases in short-term rates. Which would be an effective way of hedging this risk?a. Buy Treasury notes in the futures market.b. Sell Treasury notes in the futures market.c. Buy an option to purchase Treasury bonds.d. Sell an option to purchase Treasury bondsarrow_forwardFor the next three questions (1-3) assume what follows: Assume that you acquired a previously issued debt instrument. According to its specifications, it promised to pay $1,000 precisely in two years from the day of its original issue. At the time it was issued, investors anticipated 8.00% in interest on instruments with similar characteristics and risk level. *Note, standard rounding rules apply to all calculations! Q1. What price did you have to pay for this security - under assumption that you acquired it in a secondary market precisely three months after its original issuing, and taking into account that at the time of your acquisition investors anticipated to earn 10.00% in interest on securities with similar features and risk characteristics? A). $857.34 B). $846.37 3000K ASarrow_forwardYour friend invested part of their 401K portfolio in bonds. The bond investment has two major categories A - Bonds that have a 2 year duration (maturity) B - Bonds that have a 9-year duration (maturity). Required: Your friend told you that they have heard that interest rates will be decreasing in the near future. The question from your friend is should they place all of their money that has been invested in bonds into the 2-year duration (maturity) portfolio or the 9-year duration (maturity). The goal is to increase the total value of the bond investment. What is your answer and explain to your friend so they understand the concept?arrow_forward
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