L'Oreal, a beauty product company, issues $100 face value bonds at the price of $60. The maturity of the bond is 2 years and the bond pays coupons every six months. Which of the following statement is NOT correct?A.At maturity date, when amortization is complete, the redemption value (ignoring the final coupon) to get rid of the bonds from the balance sheet will be $100.B.The change in equity at the time of each coupon payment due to amortisation alone is a gain of $10.C.The amortization value at the time of each coupon payment is $10.D.After 1 year and a half, after the payment of a third coupon, the value of the bond recorded in the balance sheet of L'Oreal is $90.E.At the time of each coupon payment, the value of the bond in the balance sheet increases by $10.
Question
L'Oreal, a beauty product company, issues 60. The maturity of the bond is 2 years and the bond pays coupons every six months. Which of the following statement is NOT correct?A.At maturity date, when amortization is complete, the redemption value (ignoring the final coupon) to get rid of the bonds from the balance sheet will be 10.C.The amortization value at the time of each coupon payment is 90.E.At the time of each coupon payment, the value of the bond in the balance sheet increases by $10.
Solution
The statement "The change in equity at the time of each coupon payment due to amortisation alone is a gain of $10." is NOT correct.
Amortization is the process of gradually reducing a debt through scheduled, periodic payments. In the context of bonds, it refers to the gradual increase in the book value of a discount bond from its issue price to its par value as its maturity date approaches.
However, this process does not directly affect the equity of the company. Equity is the difference between a company's assets and liabilities. While the amortization of the bond increases its book value (an asset), it does not change the company's equity because there is no corresponding decrease in liabilities.
Therefore, the statement that the change in equity at the time of each coupon payment due to amortisation alone is a gain of $10 is incorrect. The amortization process increases the value of the bond (an asset), but it does not directly increase the company's equity.
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