INVESTMENTS IN
DEBT SECURITIES
PROF. ZEUS A. ABOY, CPA MBA
EDL (CANDIDATE)
Investments in debt securities represents investments in
bonds – a debt instrument.
Two parties in bond transactions:
Pays money
Bond Owner Bond Holder
Issues the bond
Promises to pay two things to the bond holder:
1) Principal at a certain time in the future
2) Periodic payments of interest
TWO INTEREST RATES YOU
SHOULD KNOW
For bonds, there are two interest rates you need to know:
1) Stated / Nominal / Coupon bond – this is the rate that is
stated in the bond certificate.
2) Effective/Market/Yield – this represents the market rate of
the bond.
FIRST ISSUE: HOW MUCH WILL
THE BOND BE ISSUED TO
INTERESTED PARTIES?
The two interest rates will come into play if we want to
determine how much the bonds will be issued.
Finding the issue price of bonds is very simple. It is equal to
the PRESENT VALUE OF THE cash flows expected from the
bonds. Meaning:
Present value of the principal
Plus: Present value of the interest
Equals to: Issue price of the bonds
EXAMPLE 1
On January 1, 2019, AEG Corp. floated a P5 Million 5-year
bond with interest rate of 6% and pays interest every
December 31. Market rate of interest is 10%.
Timeline:
12/31/2019 2020 2021 2022 2023
Today
Principal 5Million
Interest 300,000 300,000 300,000 300,000 300,000
Present value of P1 – this is used when the cash flows have
1) different amounts and 2) will be received once OR even if
in series but different amount.
Present value of Annuity – This is used when the cash flows
are the same, from one year to the other, and the time
elements are also the same.
In the timeline where are we using the two?
For the Principal, since it is a single receipt – we will use PV
value of P1.
For the interest since the amounts of interest are the same
and the intervals to receive the interest are also the same,
that is one year, we will use PV of annuity.
In computing for the present value factors, however, we will
use the Market rate, Yield or Effective.
THEREFORE:
Present values of
Principal (P5Million x .6209) P3,104,500
Interest (P300,000 x 3.7907) 1,137,210
ISSUE PRICE OF THE BONDS 4,241,710
Bond Face Amount P5,000,000
Issue Price 4,241,710
Difference – Discount since the issue price is less than
the Principal or face amount of the bonds P758,290
If the Nominal Rate is GREATER than Market Rate, the bonds
will sell at a Premium.
If the Nominal Rate is LESSER than Market Rate, the bonds
will sell at a Discount.
The Issue Price of the bonds can also be expressed in terms
of Percentage of the Face value of the bonds.
So when we say: 5M bonds will sell at 98. it means 98% of
P5Million is the issue price of the bonds.
CLASSIFICATION
1) At Amortized Cost
2) At Fair Value through Profit or Loss; and
3) At Fair Value through other comprehensive income
The above classification is based on :
1) Business model for managing the financial assets; and
2) Th Contractual cash Flow characteristic of the financial
asset.
THE BUSINESS MODEL
MAYBE ANY OF THESE:
1) Collecting cash flows that are solely payment for
principal and interest (SPPI) (AC);
2) Selling financial assets when opportunity from profit
taking arises because of fluctuations in fair values and
interest rate (P&L), or
3) Both collecting cash flows that are payment for principal
and interest and selling the asset when opportunity
arises. (OCI)
INVESTMENT IN DEBT
SECURITIES AT FV
THORUGH P&L
When the holder intends to speculate on fluctuations of
interest rates or fair value rather than to collect contractual
cash flows that are payments for principal and interest.
INITIAL RECOGNITION : AT PURCHASE PRICE, Transaction
costs, even if directly attributable to acquisition of the
assets, are taken to profit or loss.
Discount and premium are not amortized, hence the interest
revenue is based on the stated interest .
EXAMPLE (P&L)
On March 1, 2019, AEG Corp. purchased 15% P1Million fair
value bonds of ABC Corp. for P1,110,401. These bonds
mature on March 1, 2021 and pay interest semi-annually on
March 1, and September 1. At the date of acquisition, the
securities were designated by AEG as at fair value through
profit or loss. ON December 31, 2019, the bonds are quoted
in the market at P112.
INVESTMENT IN DEBT
SECURITIES AT FAIR
VALUE THROUGH OCI
Initial Measurement : at Purchase Price plus Transaction
Cost
Interest income is based on effective interest.
EXAMPLE
On January 1, 2019, AEG Corp. purchased 15% P1Million fair
value bonds of ABC Corp. for P1,110,401 a price to yield 12%
with interest payable semi annually every June 30 and
December 31. These bonds mature on March 1, 2021 and pay
interest semi-annually on March 1, and September 1. At the
date of acquisition, the securities were designated by AEG as
at fair value through profit or loss. ON December 31, 2019,
the bonds are quoted in the market at P114.
DEBT INVESTMENTS
AT AMORTIZED COST
Initial Measurement : Purchase price plus transaction costs
that are directly attributable to acquisition.
Premium and Discounts are amortized over the term of the
debt instrument using the Effective interest method. This
method gradually adjusts the original cost such that on
maturity date, the carrying value is equal to the face amount.
EXAMPLE
AEG Corp. purchased XYZ Bonds with face amount of
P1Million and stated interest rate of 15% for P1,110,401, a
price to yield 12 with interest payable every June 30 and
December 31.
