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CFA Level I · CFA Level I Exam · Analyzing Balance Sheets

A company buys a two-year, zero-coupon bond with a face value of 1,102,500 for 1,000,000, classified at amortized cost, with no transaction costs. Market rates then rise, and at the end of Year 1 the bond's fair value is 960,000. The carrying amount at the end of Year 1 and the interest income recognized in Year 1 are closest to:

The carrying amount is 1,050,000 and Year 1 interest income is 50,000. The effective rate is 5%, from the square root of 1.1025. Interest accretes to the carrying amount under amortized cost, and the decline in fair value to 960,000 is not recognized.

  1. Acarrying amount 1,000,000; interest income 0
  2. Bcarrying amount 1,050,000; interest income 50,000Correct
  3. Ccarrying amount 960,000; interest income 50,000

Explanation

Effective rate: (1,102,500/1,000,000)^(1/2) - 1 = 5%. Year 1 interest income = 5% x 1,000,000 = 50,000, added to carrying amount, giving 1,050,000 (check: 1,050,000 x 1.05 = 1,102,500). Fair value of 960,000 is irrelevant at amortized cost. Option A ignores accretion; option C uses fair value.

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