All the bonds in a particular issue may mature at the same time (term bonds) or in installments over a period of time (serial bonds). Serial bonds are like installment notes payable. Some of Southwest Airlines long-term debts are serial in nature because they are payable in installments. Secured, or mortgage, bonds give the bondholder the right to take specified assets of the issuer if the company defaults that is, fails to pay interest or principal. Unsecured bonds, called debentures, are backed only by the good faith of the borrower.
Debentures carry a higher rate of interest than secured bonds because debentures are riskier investments. •Bond Prices. Investors may buy and sell bonds through bond markets. Bond prices are quoted at a percentage of their maturity value. •Bond Premium and Bond Discount. A bond issued at a price above its face (par) value is said to be issued at a premium, and a bond issued at a price below face (par) value has a discount. Premium on Bonds Payable has a credit balance and Discount on Bonds Payable carries a debit balance. Bond Discount is therefore a contra liability account.
As a bond nears maturity, its market price moves toward par value. Therefore, the price of a bond issued at a premium decreases toward maturity value and discount increases toward maturity value. On the maturity date, a bonds market value exactly equals its face value because the company that issued the bond pays that amount to retire the bond. •The Time Value of Money. A dollar received today is worth more than a dollar to be received in the future. You can invest today’s dollar immediately and earn income from it. But if you must wait to receive the dollar, you forgo the interest revenue.
Money earns income over time, a fact called the time value of money. Let’s examine how the time value of money affects the pricing of bonds. •Bond Interest Rates Determine Bond Prices. Bonds are always sold at their market price, which is the amount investors will pay for the bond. Market price is the bondspresent value, which equals the present value of the principal payment plus the present value of the cash interest payments. Interest is usually paid semiannually (twice a year). Some companies pay interest annually or quarterly. Two interest rates work to set the price of a bond:
•The stated interest rate, also called the coupon rate, is the interest rate printed on the bond certificate. The stated interest rate determines the amount of cash interest the borrower pays and the investor receives each year. •The market interest rate, or effective interest rate, is the rate that investors demand for loaning their money. The market interest rate varies by the minute. A company may issue bonds with a stated interest rate that differs from the prevailing market interest rate. In fact, the two interest rates often differ. Reference link: http://classof1. com/homework-help/finance-homework-help