Djinn Co. made two bond investments on 1/1/17: Investment A: $5,000,000, 8% 10-y

Question

Djinn Co. made two bond investments on 1/1/17:

Investment A: $5,000,000, 8% 10-year bonds that pay interest annually on 12/31 of each year. The market rate of bonds with a comparable risk was 9%. These bonds were classified as held-to-maturity (HTM). The market rate of these bonds at 12/31/17 was 8%.

Investment B: $4,000,000, 6% 10-year bonds that pay interest annually on 12/31 of each year. The market rate of bonds with a comparable risk was 7%. These bonds were classified as available for sale (AFS). The market rate of these bonds at 12/31/17 was 7%.

Provide the balance sheet value for each of these investments at 12/31/17.

Provide income statement (net income and other comprehensive income) effects for each of these bonds.

Provide statement of cash flow effects for each of these bonds.

Ifrit Corp. had the following portfolio of equity securities at 1/1/17. The securities were purchased in prior years.

Cost at Purchase

Market Value at 12/31/16

Market Value at 12/31/17

Trading Securities

Equity Security A

4,000 shares @ $35 per share

$37 per share

$43 per share

Equity Security B

6,000 shares @ $25 per share

$30 per share

$28 per share

Available for Sale Securities

Equity Security C

5,000 shares @ $50 per share

$48 per share

$43 per share

Equity Security D

10,000 shares @ $61 per share

$65 per share

Sold 10,000 @ $73 per share

Equity Security C also pays annual dividends of $3 per share.

Provide balance sheet (asset, liability, equity) effects for each of these classes of securities for the year 2017. Note that the securities were not purchased in 2017. (6 pts)

Provide income statement effects (net income and other comprehensive income) for 2017. (6 pts)

Cost at Purchase

Market Value at 12/31/16

Market Value at 12/31/17

Trading Securities

Equity Security A

4,000 shares @ $35 per share

$37 per share

$43 per share

Equity Security B

6,000 shares @ $25 per share

$30 per share

$28 per share

Available for Sale Securities

Equity Security C

5,000 shares @ $50 per share

$48 per share

$43 per share

Equity Security D

10,000 shares @ $61 per share

$65 per share

Sold 10,000 @ $73 per share

Explanation / Answer

Bond 1

The PV (present value) of the bond is as under:

(8%X 5,000,000 X (1-(1+9%)-10)/9%) + 5,000,000 X(1=9%)10 = 4,679,117

The discount on purchase would be = 320,883 i.e. $5,000,000 - $4,679,117

Balance Sheet Impact:

At Inception

Investment in Bonds increases by $5,000,000

Discount on Bonds increases by $320,883

Cash decreases by $4,679,117

Annually

Cash increases = $400,000

Discount on Bonds decrease = $32,088.3

Income Statement Impact:

Annually

Interest Income increases = $432,088.3

Cash Flow Impact:

Inception

Cash outflow of $4,679,117

Annually

Cash inflow of = $400,000

Note: Held to Maturity bonds are not adjusted for changes in fair value. Hence the market interest rate for these bonds do not matter.

Bond 2

These bonds would be accounted similar to the above. Except that the carrying value of the bond would be adjusted for any changes in the Fair Value.

PV of the bonds are $3,719,056

Balance Sheet Impact:

At Inception

Cash decrease= $3,719,056

Investment in Bonds increase= $4,000,000

Fair Value Adjustments increase = $280,943

Annually

Cash increase = $400,000

Fair Value Adjustment decrease = $28,094.3

Income Statement Impact:

Annually

Interest Income increase= $240,000

Unrealized Gain/Loss = $28,094.3

Cash Flow Impact:

Inception

Cash outflow of $3,719,056

Annually

Cash inflow of = $240,000

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