CIA Exam - Help & Tips

BONDS

I. Concepts
A. Investors purchase bonds with the anticipation of a return on the investment.
B Investors receive a fixed rate of interest in the form of a series of cash payments based on the rate stated on the face of the bond, called the coupon rate, in addition to the principal at maturity.
C. The rate on the bonds is set by the issuer and is expressed as a percentage of the face value, also called the par value, principal amount, or maturity value.
D. The bond purchase price or selling price - present value (PV) of the maturity amount + PV of the interest payments to be received during the term of the bond.
E. The par value of the bond is calculated based on the prevailing market rate at the date of purchase.
F. If the market rate of interest is greater than the stated rate, the bond will sell at a discount; thus the bonds will sell for less than the face value to make up for the lower return. If the market rate is less than the stated rate, the bond will sell at a premium; therefore, the investor pays more than face value for the bonds due to a higher return. When the market rate is equal to the stated rate, the bond will sell at face value.
G. Only use the stated rate to calculate the interest payments. However, use the market rate to determine the PV of the principal and the interest.
H. The market rate and the stated rate may be identical, but it's more probable that the rates will differ it there's a time lag between the date the rate is determined and the date of the bond.

II. Definitions
A. Secured Bond - requires collateral as a guarantee to pay back the debt.
B. Unsecured Bond (debenture bond) - used to finance a new marketing plan.
C. Zero Coupon Bond - pays no interest.
D. Bond Indenture - the document (contract) that describes the relationship between the issuer (borrower) and the bondholder (lender); it represents a promise to pay.
E. Face Value - total dollar amount of the bond that serves as the basis for which periodic interest is paid.
F. Stated (Nominal) Rate - interest rate paid to investors, this rate is specified in the bond indenture.
G. Market (Effective, Yield) Interest Rate - the stated rate adjusted at the time of the bond issuance for a premium or discount.
H. Treasury Bonds - bonds payable which have been reacquired, but not retired by the issuer; they are shown on the balance sheet as a deduction from bonds payable issued.
I. Par Value - stated face value of the bonds (principal).
J. Maturity Date - the date the par value must be paid.
K. Stated Rate - coupon interest rate, coupon payment, contract rate, nominal rate.
L. Market Rate - yield, effective rate, effective interest rate.
M. Call Provision - allows the issuer to redeem the bonds under specified terms prior to the maturity date.
N. Borrower or Issuer - corporation who sells the bonds.
0. Investor (Lender, Investor in Bonds) - purchaser of the bonds.
P. Amortization of Cost of Issuance - recognition of a capitalized cost over the life of a given bond issue.

III. Journal Entries

A. The journal entry to record the sale of bonds (discount):
DR. Cash (proceeds)
DR. Discount on bonds payable
CR. Bonds Payable

B. The journal entry to record the sale of bonds (premium):
DR. Cash (proceeds)
CR. Premium on bonds payable CR. Bonds Payable

C. The journal entry to record the purchase of bonds (investor's books):
DR. Bond investment Cash
CR. Cash

D. The journal entry to amortize bond premium or discount:
When issued at a discount
DR. Bond interest expense
CR. Discount on bonds payable

When issued at a premium
DR. Premium on bonds payable
CR. Bond interest expense

Questions on bonds:
1. On January 1, 1996, a company issued a 10 year. The bond bears interest at 12 percent, payable on January 1 and July 1. The entry to record the issuance of the bond on January 1 would be:
a. Dr. Cash $480,000; Cr. Bonds Payable $480,000
b. Dr.Cash $500,000; Cr. Bonds Payable $500,000
c. Dr. Cash $480,000; Dr. Disc on Bonds Payable $ 20,000;Cr. Bonds Payable $500,000
d. Dr. Cash $500,000; Cr. Premium on Bonds Payable $ 20,000; Cr. Bonds Payable $480,000

2. The effective-interest method and the straight-line method of amortizing a bond discount differ in that the effective interest method results in:
a. Higher total interest expense over the term of the bonds.
b. Escalating annual interest expense over the term of the bonds.
c. Shrinking annual interest expense over the term of the bonds.
d. Constant annual interest expense over the term of the bonds.

3. In calculating fully diluted earnings per share when a company has convertible bonds outstanding, the number of common shares outstanding must be - List A - to adjust for the conversion feature of the bonds, and the net income must be - List B - by the amount of interest expense on the bonds, net of tax.
a. List A Increased; List B Increased
b. List A Increased; List B Decreased
c. List A Decreased; List B Increased
d. List A Decreased; List B Decreased

4. Preferred stock is a security with characteristics of both common stock and bonds. Preferred stock has like common stock and like bonds.
List A
a. a maturity date
b. no maturity date
c. a maturity date
d. no maturity date

List B
a. a fixed periodic payment
b. no fixed periodic payment
c. no fixed periodic payment
d. a fixed periodic payment

5. If a company has outstanding bonds with a sinking fund provisiorr and if interest rates have since the bands were issued, then the company would realize a savings in meeting its sinking fund obligations by .
a. List A Increased; List B Buying back bonds in the open market
b. List A Remained constant; List B Calling in a portion of the bonds at face value
c. List A Increased; List B Calling in a portion of the bonds at face value
d. List A Decreased; List B Buying back bonds in the open market

6. A company issues bonds with a 10 percent coupon rate at a time when the market interest rate on bonds of similar risk and maturity is 15 percent. The format of the journal entry that the company would use to record the issuance is:
a. Debit Cash; Debit Premium on Bonds Payable; Credit Bonds Payable
b. Debit Cash; Credit Premium on Bonds Payable; Credit Bonds Payable
c. Debit Cash; Debit Discount on Bonds Payable; Credit Bonds Payable
d. Debit Cash; Credit Discount on Bonds Payable; Credit Bonds Payable

7. A company issues 10-year bonds with a face value of $1,000 000, dated January 1, 19S4 and bearing interest at an annual rate of 12 percent payable semi-annually an January 1 and July 1. The full interest amount will be paid each due date. The market rate of interest on bonds of similar risk and maturity, with the same schedule of interest payments, is also 12 percent. If the bonds are issued on February 1, 1994, the amount the issuing company receives from the buyers of the bonds on that date is:
a. $990,000
b. $1,000,000
c. $1,010,000.
d. $1,020,000.

8. Bondholders are assured of protection against inflation if they hold:
a. Income bonds.
b. Convertible bonds.
c. Mortgage bonds.
d. Indexed bonds.

9. Compared to another bond with the same risk and maturity but without a convex
a. Higher face value.
b. Lower face value.
c. Higher coupon rate.
d. Lower coupon rate.

10. If the market rate of interest is [List A] the coupon rate when bonds are issued, then the bonds will sell in the market at a price (List B] the face value and the issuing firm will record a [List C] on bonds payable. List A List B List C
a. List A equal to; List B equal to; List C premium
b. List A greater than; List B greater than; List C premium
c. List A greater than; List B less than; List C discount
d. List A less than; List B greater than; List C discount

11. Convertible bonds and bonds issued with warrants differ in that:
a. Convertible bonds have lower coupon rates than straight bonds while bonds issued with warrants have higher coupon rates than straight bonds.
b. Convertible bonds have higher coupon rates than straight bonds while bonds issued with warrants have lower coupon rates than straight bonds.
c. Convertible bonds remain outstanding after the bondholder exercises the right to become a common shareholder, while bonds that are issued with warrants do not.
d. Bonds that are issued with warrants remain outstanding after the

12. Which of the following is a characteristic of a bond that is issued at a discount?
a. The coupon rate exceeds the market rate on bonds of similar risk and maturity.
b. Interest is paid semiannually rather than annually.
c. The market value of the bond approaches its par value as the maturity date approaches.
d. The market value of the bond fans between the date of issue and the

13. If bonds payable with a carrying value equal to par value are refunded by use of a call provision, the call premium of the refunded issue should be:
a. Amortized over the remaining original life of the extinguished issue.
b. Amortized over the life of the new issue.
c. Recognized currently in income as an extraordinary loss.
d. Recognized currently as a loss and reported as a component of income

14. From the viewpoint of the investor, which of the following securities provides the least risk;
a. Mortgage bond.
b. Subordinated debenture.
c. Income bond.
d. Debentures.

15. A bond backed by fixed assets is known as a(n)
a. Income bond.
b. Subordinated debenture.
c. Debenture.
d. Mortgage bond.

16. Which is the appropriate classification of bonds payable and the related accrued interest payable on the December 31, 1992, balance sheet?

classification A, Bonds Payable Current Liability; Interest Payable Current Liability
classification B, Bonds Payable Current Liability; Interest Payable Long Term Liability
classification C, Bonds Payable Long-term Liability; Interest Payable Currrent Liability
classification D, Bonds Payable Long-term Liability; Interest Payable Long-term Liability

a. Classification A.
b. Classification B.
c. Classification C.
d. Classification D.

17. Zero coupon bonds issued by corporations:
a. Are initially sold at par value (a zero discount)
b. Are initially sold for a price above par value.
c. Are tax free.
d. Require no cash outlay from the issuer until the bonds mature.

18. An investor is presently holding income bonds, debentures, subordinated debentures, and first-mortgage bonds. which of these securities
a. Income bonds.
b. Debentures.
c. Subordinated debentures.
d. First-mortgage bonds.

19. A possible major advantage of a holding company is that:
a. It can isolate risks to a single unit.
b. It is not taxed on profits it receives.
c. It is not subject to normal regulations that apply to all other
d. It can issue tax-free bands.

20. A company issued long-term bonds and used the proceeds to repurchase 40 percent of the outstanding shares of its stock. This financial transaction will likely cause the,
a. Total assets turnover ratio to increase.
b. Current ratio La decrease.
c. Times-interest-earned ratio to decrease.
d. Fixed charge coverage ratio to increase.

21. Zero coupon bonds:
a. Sell for a small fraction of their face value because their yield is much lower than the market rate
b. Increase in value each year as they approach maturity, providing the owner with the total payoff at maturity.
c. Are redeemable in measures of a commodity such as barrels of oil,
d. Are high interest rate, high risk, unsecured bonds which have been

Answers: 1. C 12. C 2. b 13. C 3. a 14. a 4- d 15. d 5. a 16. a 6. c 17. d 7. c 18. d 8. d 19. a 9. d 20. c 10. c 21. b 11. d

Contact Us /Home/ About Us/ Services/ Current Issues
Audit Services Tel:615-790-9858 Fax: 209-797-7983 PO Box 681387, Franklin, TN 37068