Question

On January 2, 2025, Hill Corp. issued 5-year, $1,000,000 bonds at par. Interest is payable annually on December 31 at a stated fixed rate of 6.0%. To mitigate interest rate risk, Hill Corp. entered into a 5-year interest rate swap with a swap bank on January 2, 2025. Terms of the contract were as follows: Hill Corp. agreed to pay a variable rate of interest to the swap bank. In return, Hill Corp. will receive fixed rate interest from the swap bank. Interest rates during 2025 were the following: Date Fixed rate Market rate January 2, 2025 6.0% 6.0% December 31, 2025 6.0% 5.2% As a result of the decrease in the market interest rate during 2025, both the debt obligation and swap contract increased during 2025. Specifically, as of December 31, 2025, the bond liability and interest rate swap had a fair value of $1,028,236 and $28,236, respectively.

Required:
1. Prepare the appropriate journal entry or entries for each transaction. (If no entry is required for a transaction/event, select "No journal entry required" in the first account field.)
2. Indicate any amounts that Hill Corp. would report in its December 31, 2025 balance sheet and income statement related to the interest rate swap.

Answer 1

To calculate the present value of a bond, apply the present value formula to its future payments using the discount rate. For a bond with 8% interest rate, when the discount rate is also 8%, the present value is $2,898.15. If the discount rate increases to 11%, the present value decreases to $2,808.24.

Step-by-step explanation:

When determining the present value of future payments from a bond, we can use the formula for present value, which takes into account the future cash flows and the discount rate. Here's how we would calculate it for a simple two-year bond that was issued at $3,000 with an interest rate of 8%. The bond pays $240 in interest each year, and the principal of $3,000 at the end. Using a discount rate of 8%, the present value of the first year's interest is $240 / (1 + 0.08) = $222.22, and the present value of the second year's interest and principal is ($240 + $3,000) / (1 + 0.08)^2 = $2,675.93. So, the total present value is $222.22 + $2,675.93 = $2,898.15.

If interest rates increase and the new discount rate is 11%, the present value calculations would change to $240 / (1 + 0.11) = $216.22 for the first year, and ($240 + $3,000) / (1 + 0.11)^2 = $2,592.02 for the second year. The new total present value is $216.22 + $2,592.02 = $2,808.24. Since the market interest rate has risen, the present value of the bond decreases, reflecting its lower market price compared to when the discount rate was 8%.