Reference no: EM132419532
Assume a $600,000 bond with a 3% coupon rate that was sold at a discount to yield 4%. At the end of Period 2, the bond has a carrying amount on the balance sheet of $588,576.81. Assume that at the end of Period 2, the market rate of interest declines from 4%, when the bond was issued, to 2% (1% semiannually). The drop in market rates will affect the market value of the bond. At the end of Period 2, there are four interest payments of $9,000 remaining plus the $600,000 face amount of the bond at maturity. The present value of that stream of payments, discounted at the current market rate of a 1% semiannual rate, is equal to $611,705.90 (the Excel formula is PV(1%, 4, -9,000, -600,000)). To repurchase the bond, the firm would have to issue a new bond in the amount of $611,705.90 carrying a 1% coupon rate. Either way, the firm would report a loss on the early extinguishment of debt of $23,129.09 ($611,705.90 - $588,576.81). Despite reporting an accounting loss on the early extinguishment of debt of $23,129.09, there is no economic loss. Why?
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