In 20X5, Kahn Financial Group used the Fair Value option for some of its own debt. During the first quarter of 20X5, the
Posted: Mon Apr 25, 2022 7:41 am
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: 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.
Suppose the market interest rate had increased to 12 % by January
1, 20X5. Compute the market value of the bonds on that date. During
the first quarter of 20X5, Kahn’s debt lost value in the bond
market because of investor’s 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. How did Kahn account for the $2.7
billion decline in the value of its own debt in 20X5? Explain why
the fair value option accounting treatment used by Kahn might be
considered controversial.
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: 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.
Suppose the market interest rate had increased to 12 % by January
1, 20X5. Compute the market value of the bonds on that date. During
the first quarter of 20X5, Kahn’s debt lost value in the bond
market because of investor’s 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. How did Kahn account for the $2.7
billion decline in the value of its own debt in 20X5? Explain why
the fair value option accounting treatment used by Kahn might be
considered controversial.