Determining Bond Prices, Interest Rates, and Financial Statement Effects
Assume Deere & Company's 2012 10-K reports the following footnote relating to long-term debt.
Deere's borrowings include $300 million, 7.125% notes, due in 2031 (bolded below).
Long term borrowings at October 31 consisted of the following in millions of dollars:
|Notes and Debentures||2012||2011|
|7.85% debentures due 2015||$306||$306|
|6.95% notes due 2019: ($700 principal) Swapped to variable interest rates of 6.1%-2012, 6.4%-2011||743||734|
|8.95% debentures due 2019||56||56|
|8-1/296 debentures due 2022||105||105|
|6.55% debentures due 2028||200||200|
|8.10% debentures due 2030||250||250|
|7.125% notes due 2031||300||300|
A recent price quote (from Yahoo! Finance Bond Center) on Deere's 7.125% notes follows.
|Type||Issuer||Price||Coupon (%)||Maturity||YTM (%)||Current Yield (%)||Fitch Rating||Callable|
|Corp||Deere & CO||134.13||7.125||3-Mar-2031||4.648||5.312||A||No|
This price quote indicates that Deere's 7.125% notes have a market price of 134.13 (134.13% of face value), resulting in a yield to maturity of 4.648%.
(a) Assuming that these notes were originally issued at par value, what does the market price reveal about interest rate changes since Deere issued its notes? (Assume that Deere's credit rating has remained the same.)
- O Interest rates have increased.
- O Interest rates have declined.
- O There is not enough information.
- O Interest rates have remained the same.
What Is A Bond Premium:
A Bond Premium is presented on the financial statements as a liability. It reflects the excess consideration received from the bond issuance above the bond's fa value due to differences between the market rate and coupon rate.
Answer and Explanation:
It is clear that interest rates have declined.
- This is because of the very high price of 134% of face value for its long-term notes maturing in over 10 years.
- When interest rates decline, bonds that pay a higher coupon rate such as 7.125% will appreciate in value (i.e. higher market price) because the high coupon payment is even more attractive when interest rates are lower.
Therefore the answer is: Interest rates have declined.
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from Financial Accounting: Help and ReviewChapter 5 / Lesson 26