115 CFA
File: Financial Analysis - Reading 28 - 2. Current Market Rates and Fair Value Reporting Option

2. Current Market Rates and Fair Value Reporting Option

a. determine the initial recognition, initial measurement and subsequent measurement of bonds;

b. describe the effective interest method and calculate interest expense, amortisation of bond discounts/premiums, and interest payments;

What is considered the market value of a company's debt?
The market value of a company's debt is either the market price, if it is traded, or the present value of the future cash flows. The discount rate that is used is a risk-free rate, plus an appropriate spread for the risk of the particular company.

How is debt reported on the balance sheet?
Debt reported on the balance sheet is equal to the present value of future cash payments discounted at the market value rate on the date of issuance.

For a company that has issued debt with a fixed interest rate, what happens to the value of the debt is the market rate increases/decreases/floats?
- When interest rates increase, the market value of fixed-rate debt decreases.
- When interest rates decrease, the market value of fixed-rate debt increases.
- For floating-rate debt, increases or decreases in interest rates do not have an impact on market value, as future cash flows will change along with the changes in interest rates.

If a firm has variable-rate long-term debt outstanding, and interest rates rise, what is the impact on the firm's debt-to-equity ratio?
Interest has increased, which means income decreases. Retained earnings are therefore lower and the debt-to-equity ratio will increase.

  • CFA