Distinguish between nominal and effective interest rates

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Reference no: EM13148910

A company issues 10 year 8% bonds having a par value of $2 million dollars. The interest on the bonds is paid quarterly on March 31st, June 30th, September 30th, December 31st.

The proceeds to the company on the day the bonds were issued - January 1st - was 1.9 million dollars. On June 30th of year one, the bonds were being traded at 98 and a half and each of the following was suggested as a possible valuation basis for reporting the bond liability on the balance sheet.

a) 1,905,000 (plus six months' straight-line amortization)

b) 2,000,000 (face value)

c) 3,520,000 (face value plus interest payments)

d) 1,970,000 (fair value)

i) Distinguish between nominal and effective interest rates.

ii) Explain the nature of the $100,000 difference between the face value and the market value of the bonds on January 1

iii) Between January 1 and June 30, what happened to the market value of the company's bonds? Explain and discuss the significance to the company.

iv) Evaluate each of the four suggested reporting amounts on the balance sheet, giving arguments for and against each alternative.

v) for item iv) include a discussion of the investor and how the investor should record on January 1st and June 30th.

Reference no: EM13148910

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