Bond Amortization, Retirement and Value of a Bond

Bond Amortization

 A bond amortization is a financial certificate that has been reduced in value for recording on financial
statements. It is one where the discount amount being amortized becomes part of its interest
expense over the life of the bond.

 For example, North Valley Regional High School, in response to much-needed improvements, issued a
15-year amortized bond to help fund operating costs and capital improvements. The bond is projected to
cost $323,000 and should reduce the taxpayers burden of the general fund being used to make these
needed improvements to the school.

Retirement

 Technically, “retirement of bonds” is an accounting term that you’ll see used on financial statements. It
refers to a buyback of bonds previously sold.

 In other words, it means a bond issuer has paid off the debt represented by the bonds.
 For example, on a company’s cash statement, retirement of bonds may be used to explain a reduction in
the firm’s long-term debt.

Value of a Bond
 A bond is issued with a stated value, known as the par, or face value.
 A bond is a debt instrument that provides a periodic stream of interest payments to investors while
repaying the principal sum on a specified maturity date. A bond’s terms and conditions are contained in
a legal contract between the buyer and the seller, known as the indenture.

Key Bond Characteristics

Each bond can be characterized by several factors. These include:

 Face Value
 Coupon Rate
 Coupon
 Maturity
 Call Provisions
 Put Provisions
 Sinking Fund Provisions

a) Face Value

The face value (also known as the par value) of a bond is the price at which the bond is sold to investors when
first issued; it is also the price at which the bond is redeemed at maturity. In the U.S., the face value is usually
$1,000 or a multiple of $1,000.
b) Coupon Rate

The periodic interest payments promised to bond holders are computed as a fixed percentage of the bond’s face
value; this percentage is known as the coupon rate.

c) Coupon

A bond’s coupon is the dollar value of the periodic interest payment promised to bondholders; this equals the
coupon rate times the face value of the bond. For example, if a bond issuer promises to pay an annual coupon
rate of 5% to bond holders and the face value of the bond is $1,000, the bond holders are being promised a
coupon payment of (0.05)($1,000) = $50 per year.

d) Maturity

A bond’s maturity is the length of time until the principal is scheduled to be repaid. In the U.S., a bond’s
maturity usually does not exceed 30 years. Occasionally a bond is issued with a much longer maturity; for
example, the Walt Disney Company issued a 100-year bond in 1993. There have also been a few instances of
bonds with an infinite maturity; these bonds are known as consols. With a consol, interest is paid forever, but
the principal is never repaid.

e) Call Provisions

Many bonds contain a provision that enables the issuer to buy the bond back from the bondholder at a pre-
specified price prior to maturity. This price is known as the call price. A bond containing a call provision is
said to be callable. This provision enables issuers to reduce their interest costs if rates fall after a bond is issued,
since existing bonds can then be replaced with lower yielding bonds. Since a call provision is disadvantageous
to the bond holder, the bond will offer a higher yield than an otherwise identical bond with no call provision.
A call provision is known as an embedded option, since it can’t be bought or sold separately from the bond.

f) Put Provisions

Some bonds contain a provision that enables the buyer to sell the bond back to the issuer at a pre-specified price
prior to maturity. This price is known as the put price. A bond containing such a provision is said to
be putable. This provision enables bond holders to benefit from rising interest rates since the bond can be sold
and the proceeds reinvested at a higher yield than the original bond. Since a put provision is advantageous to
the bond holder, the bond will offer a lower yield than an otherwise identical bond with no put provision.

g) Sinking Fund Provisions

Some bonds are issued with a provision that requires the issuer to repurchase a fixed percentage of the
outstanding bonds each year, regardless of the level of interest rates. A sinking fund reduces the possibility
of default; default occurs when a bond issuer is unable to make promised payments in a timely manner. Since a
sinking fund reduces credit risk to bond holders, these bonds can be offered with a lower yield than an
otherwise identical bond with no sinking fund.