Question

On January 1, a company issues a $100,000, three-year note that pays 9% interest annually. The market rate on the note is 6%. How much of the note premium should the company amortize in the first year

Answer 1

The company amortize note premium of $2,518.80 in the first year.

Step-by-step explanation:

First we need to determie price of the note

Price of the bond = [ I x ( 1 - ( 1 + r )^-n ) / r ] + [ F / ( 1 + r )^n ]

Where

F = Face value = $100,000

I = Periodic Interest payment = $100,000 x 9% = $9,000

r = Periodic interest rate = 6%

n = Numbers of periods = 3

Placing values in the formula

Price of the Note = [ $9,000 x ( 1 - ( 1 + 6% )^-3 ) / 6% ] + [ $100,000 / ( 1 + 6% )^3 ]

Price of the Note = $24,057.11 + $83,962.93

Price of the Note = $108,020.04

Price of the Note = $108,020

Calculate the premium

Premium = Price of the note - Face value of the note = $108,020 - $100,000 = $8,020

Now use following formula to calculate the amortization of the premium

Amortization = ( Face vale x stated Interest rate ) - ( Price of the bond x Market interest rate ) = ( $100,000 x 9% ) - ( $108,020 x 6% ) = $2,518.80