CMA Training Video | Corporate Finance Long-Term Financial Management | By Varun Jain
Miles Education - CPA, CMA, CFA
We are discussing financial instruments, which are transactions between two parties. One party
invests, and the other engages in a financing activity.One example of a financial instrument is a
bond. When an investor purchases a bond, they receive a piece of paper representing their
investment. In this case, the investor gave $100,000 and received a bond.Over the next five
years, the issuer will pay interest on the bond at 7 percent annually. Depending on the type of
bond issued, it may be secured by real property or be a convertible bond.A convertible bond is
similar to a convertible car. With a car, you can remove the roof and enjoy the fresh air.
Similarly, a convertible bond can be converted into equity in the company.In this case, an
unsecured bond was issued because investors trust the issuer.
Halleck had the option of issuing a zero coupon bond. Zero coupon bonds are bonds that do not
offer any interest payments to the investor. For instance, in this case, an interest rate of seven
percent would have been zero percent. However, it is doubtful if anyone would have been
willing to take such a bond. Let us assume he is asking an investor to give him one hundred
thousand dollars now and come back after five years to take back his investment. If the market
rate of interest for their credit rating goes up to 8% in that time, would anyone still buy Halleck's
seven percent bonds? It's unlikely, as they could get a better rate elsewhere. So, Halleck cannot
rely on the 7% interest rate alone to attract Jay or any other investor. So he decides to offer
some discount on his bonds to motivate investors like Jay. Contagioio recommends "monetizing
it on a straight-line method," meaning he suggests that Halleck debit the discount on bond
issuance account to amortize it later by crediting it to the interest expense account. It is
essential to note that Halleck will have to pay seven thousand dollars cash out each year for
interest expense.
Miles Education - CPA, CMA, CFA
We are discussing financial instruments, which are transactions between two parties. One party
invests, and the other engages in a financing activity.One example of a financial instrument is a
bond. When an investor purchases a bond, they receive a piece of paper representing their
investment. In this case, the investor gave $100,000 and received a bond.Over the next five
years, the issuer will pay interest on the bond at 7 percent annually. Depending on the type of
bond issued, it may be secured by real property or be a convertible bond.A convertible bond is
similar to a convertible car. With a car, you can remove the roof and enjoy the fresh air.
Similarly, a convertible bond can be converted into equity in the company.In this case, an
unsecured bond was issued because investors trust the issuer.
Halleck had the option of issuing a zero coupon bond. Zero coupon bonds are bonds that do not
offer any interest payments to the investor. For instance, in this case, an interest rate of seven
percent would have been zero percent. However, it is doubtful if anyone would have been
willing to take such a bond. Let us assume he is asking an investor to give him one hundred
thousand dollars now and come back after five years to take back his investment. If the market
rate of interest for their credit rating goes up to 8% in that time, would anyone still buy Halleck's
seven percent bonds? It's unlikely, as they could get a better rate elsewhere. So, Halleck cannot
rely on the 7% interest rate alone to attract Jay or any other investor. So he decides to offer
some discount on his bonds to motivate investors like Jay. Contagioio recommends "monetizing
it on a straight-line method," meaning he suggests that Halleck debit the discount on bond
issuance account to amortize it later by crediting it to the interest expense account. It is
essential to note that Halleck will have to pay seven thousand dollars cash out each year for
interest expense.
