Question

On July 1, 20X3, the City of Chelan issued $2,000,000 of 6percent tern bonds maturing in five years on July 1, 20X8. Interest on the bonds is payable semiannually on January 1 , and July 1 , with the first interest payment falling due on January 1,20X4. A sinking fund is to be established, with equal additions to be made on the interest dates each year beginning on January 1,20X4 . Sinking fund investments are expected to yield a return of 6 percent per year, compounded semiannually. Investment earnings are added to the sinking fund principal. The attached transactions occurred during the year that affected the city’s debt service fund for fiscal year 20X8 REQUIRED: (1) calculate the amount of the annual addition that will be necessary beginning on January 1 20X4 to adequately fund the sinking fund to retire the term bonds. Round your answer to nearest whole dollar. (2) Prepare a schedule, in good form, showing the required additions to the sinking fund for each of ten periods. (3) Prepare entries in general journal form to reflect the above transactions or information for the fiscal year ended June 30, 20X8 only. Disregard any entries that should be made in the General Fund. Make only entries required for the Debt Service Fund. Use the letter of the transaction as the entry date Omit explanations. (1) On July 1, 20X7, the budget for fiscal year 20X8 was enacted approving operating transfers from the General Fund necessary for the Debt Service Fund appropriations for the interest payments due on July 1 20X7, and January 1 20X8, the sinking fund additions due on January 1 and July 1 ,20X8, and the estimated earnings that will be received on the sinking fund for the fiscal year. (2) On July 1,20X7, operating transfers were made from the General Fund to the Term Bond Debt Service Fund to pay the interest due and the sinking fund addition required on July 1, 20X7. (3) The semiannual interest payment due on July 1, 20X7 was made. The interest had not been previously accrued. In addition, the appropriate amount was transferred to the sinking fund. The amount was immediately invested in approved investments for the fund. (4) The earnings on the sinking fund investments for the six months ending July 1 ,20X7 were received. The amount had previously been accrued as interest receivable. The amount was immediately reinvested. (5) On January 1, 20X8, another transfer was made from the General Fund for the January 1, 20X8 interest payment and addition to the sinking fund. (6) The interest payment due on January 1, 20X8, was made on schedule. The sinking fund transfer was invested. (7) The earnings on the sinking fund investments for the six months ending January 1 ,20X8 were received. The amount was immediately reinvested. (8) The earnings on the sinking fund investments for the six months ending July 1,20X8 were accrued

Answer 1

An investor looking to buy a $10,000 bond with a 6% interest rate when market interest rates are 9% would expect to pay less than the face value of the bond. The price they are willing to pay is determined by the present value of the bond's remaining cash flows discounted at the current market interest rate of 9%.

Step-by-step explanation:

When considering the purchase of a bond one year before maturity, an investor needs to compare the bond's interest rate with the current market interest rates. In this scenario, the existing bond has a 6% interest rate, and the current market rate is 9%. As market interest rates rise above the coupon rate of the bond, the bond's price will typically fall below its face value because its fixed interest payments are less attractive compared to new issues paying higher rates.

The present value of future cash flows from the bond will determine the price an investor would be willing to pay for it. With the increase in interest rates from 6% to 9%, the investor would expect to pay less than the face value, or $10,000, for the bond.

To calculate the exact price one would be willing to pay for the $10,000 face value bond, one needs to calculate the present value of the bond's remaining cash flows (one year of interest plus the principal at maturity) discounted at the new market rate of 9%.