CFA CFA Level 1 int expense

# int expense

• Author
Posts
• pcunniff
Participant
• CFA Level 1
5

Hey! Where are they getting \$10,366 from? Would appreciate any help here!

Assume a city issues a \$5 million semiannual-pay bond to build a new arena. The bond has a coupon rate of 8% and will mature in 10 years. When the bond is issued its yield to maturity is 9%. Interest expense in the second semiannual period is closest to:

A)

\$80,000.

B)

\$210,830.

C)

\$106,550.

Step 1: Compute the proceeds raised (i.e., the present value of the bond): Since the yield is above the coupon rate the bond will be issued at a discount.

FV = \$5,000,000; N = (10 Ã— 2) = 20; PMT = (0.08 / 2)(5 million) = \$200,000; I/Y = (9 / 2) = 4.5; CPT â†’ PV = -\$4,674,802

Step 2: Compute the interest expense at the end of the first period.

= (0.045)(4,674,802) = \$210,366

Step 3: Compute the interest expense at the end of the second period.

= (new balance sheet liability)(current interest rate)

= \$4,674,802 + \$10,366 = \$4,685,168 new balance sheet liability

(0.045)(4,685,168) = \$210,833

(Study Session 8, Module 28.2, LOS 28.b)

• rahul12
Participant
• CFA Level 3
2

\$10,366 is the difference between the interest expense at the end of year 1 (\$210,366) and the coupon payment (\$200,000).

you need to adjust the balance sheet’s bond liability end of 1st period to calculate 2nd period’s interest expense.

the ending bond liability = beginning bond liability (\$4,674,802) + change in bond liability (\$210,366 – 200,000) = \$4,685,168

therefore, 2nd period’s interest expense is 4.5% x 4,685,168 = \$210,833