Final answer:
The value of a bond depends on the coupon rate and the market interest rate. If the market rate exceeds the bond's coupon rate, the bond's present value will be less than its face value. Journal entries for bond issuance and interest reflect the bond's carrying value and effective interest rates.
Step-by-step explanation:
Calculation of Bond Value
When calculating the value of the bond, the key factors to consider are the face value, the coupon rate, and the market interest rate. If we take the example of a simple two-year bond issued at $3,000 with an 8% interest rate, it would pay $240 annually in interest. The current value of this bond would depend on the discount rate, which represents the market interest rate for similar risk bonds. If the discount rate is the same as the coupon rate (8%), then the bond's present value would be equal to its face value because the coupon rate is the same as the required return. The calculations are made using the present value formula, typically found in financial tables or calculated using a financial calculator.
If the market interest rate rises to 11%, the bond becomes less attractive, and its present value would decrease. This is because the fixed coupon payments and the return of principal are discounted at a higher rate, resulting in a lower present value. It reflects the risk that there are alternative investments available that could offer a higher return.
Journal Entries for Issuance and Interest Payments
The journal entries to record the issuance of bonds and the interest payments at the effective rate are based on the carrying amount of the bond and the effective interest rate. When the market interest rate is higher than the coupon rate, bonds are issued at a discount, and the effective interest on each payment date is calculated as the carrying amount of the bond multiplied by the market rate divided by two (since interest payments are semiannual).