Answer:
a. the price bonds sell for at insurance is $252.57
b. interest deduction can the company take on these bonds in the first year and last year under IRS amortization is $71.2 and 0 respectively
c. interest deduction can the company take on these bonds in the first year under straight-line method is $37.37
Explanation:
a. semiannual compounding periods for 20-year is 40
zero coupon rate then its future value is $1,000, thus the present value of this bond = $1,000/(1+7%/2)^40 = $252.57 or in excel = PV(3.5%,40,,1000)
b. The IRS requires that the constant yield method be used to amortize a bond premium every year. The constant yield method amortizes a bond premium by multiplying the adjusted basis by the yield at issuance and then subtracting the coupon interest.
Accrual = Purchase Basis x (Yield To Maturity /Accrual periods per year) – Coupon Interest
in which YTM =[tex]\sqrt[20]{face value/ current price}[/tex]-1
= (1000/252.57)^(1/20)-1 = 7.12%
Accrual for 1st year = (1000*(7.12%/2)-0)*2 = $71.2
which this IRS amortization, the company will fully deduct interest expense in 16 year = NPER(3.56%,35.6,747.43)
c. under straight-line method, the interest deduction the company can take in the first year and last year are same = ($1,000-$252.57)/20 = $37.37
