In 20X5, Kahn Financial Group used the fair value option for some of its own debt. During the first quarter of 20X5, the

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In 20X5, Kahn Financial Group used the fair value option for
some of its own debt.
During the first quarter of 20X5, the fair value of its debt
declined by $2.7 billion. Its
reported net income for the quarter was $1.6 billion.
Required:
1. Suppose Kahn Financial had issued at par on January 1, 20X1,
$500 million of 10-year
bonds with a fixed annual interest rate of 6%, reflecting the
company's financial
soundness at the time. Calculate the proceeds received by Kahn, the
interest expense
recorded in 20X1, and the bond carrying value on January 1, 20X5.
Assume cash
interest payments are made on December 31 of each year.
2. Suppose the market interest rate had increased to 12% by January
1, 20X5. Compute
the market value of the bonds on that date.
3. During the first quarter of 20X5, Kahn's debt lost value in the
bond market because of
investors' concerns about the company's ability to meet required
debt payments when
due. Explain how this perceived increase in Kahn's credit risk
translates into a decline
in the market value of its bonds.
4. How did Kahn account for the $2.7 billion decline in the value
of its own debt in 20X5?
5. Explain why the fair value option accounting treatment used by
Kahn might be
controversial.
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