Question

Items 3-7 are based on the following information. During the fiscal year ending December 31, 2015, the City of X issued 6 percent general obligation bonds in the amount of $2,000,000 at par and used $1,990,000 of the proceeds to construct a police station. The remaining $10,000 was transferred to a debt service fund. The bonds were dated November 1, 2015, and paid interest on May 1 and November 1. The first of 20 equal annual principal payments was due on November 1, 2016.

5.How would the government account for the $10,000 unused funds?
a. As a revenue in a debt service fund and as an expenditure in a capital projects fund.
b. As an asset in a capital projects fund and as a liability in a debt service fund.
c. As another financing source in a capital projects fund and as another financing use in a debt service fund.
d. As another financing source in a debt service fund and as another financing use in a capital projects fund.

Answer 1

You would expect to pay less than the $10,000 face value of the bond due to the increase in interest rates from 6% to 9%. The present value calculation shows you would be willing to pay $9724.77 for the bond, considering the present value of future cash flows discounted at the current 9% market rate.

Step-by-step explanation:

When considering the purchase of a bond one year before its maturity when interest rates have risen from 6% to 9%, you would expect to pay less than the face value of the bond which is $10,000. This is because the bond's fixed interest payments are less attractive compared to the new higher market rate of 9%, thus its price must decrease to offer a competitive yield to potential buyers.

To calculate what you would actually be willing to pay for this bond, we need to find the present value of the bond's remaining cash flows (interest and principal repayment) discounted at the current market rate of 9%. The bond will have one more interest payment of $600 ($10,000 x 6%) and a principal repayment of $10,000. Using the present value formula for a single sum, the present value of the interest payment is $600 / (1 + 0.09) = $550.46, and the present value of the principal is $10,000 / (1 + 0.09) = $9174.31. Therefore, the total present value, or price you should be willing to pay for the bond today, is $550.46 + $9174.31 = $9724.77.