Chapter 10

Investments in Debt Securities

PROBLEM 1: TRUE OR FALSE

1. TRUE
2. FALSE
3. TRUE
4. TRUE
5. FALSE

PROBLEM 2: FOR CLASSROOM DISCUSSION

1. Solutions:
Requirement (a):
Interest Interest Present
Date received income Amortization value
1/1/x1 941,726
1/1/x2 120,000 131,842 11,842 953,568
1/1/x3 120,000 133,499 13,499 967,067
1/1/x4 120,000 135,389 15,389 982,457
1/1/x5 120,000 137,544 17,544 1,000,000

Requirement (b):
(1,000,000 – 967,067) = 32,933 discount

Requirement (c):
1/1/x1
Investment in bonds 967,067
Cash in bank 967,067

12/31/x1
Interest receivable 120,000
Investment in bonds 11,842
Interest income 131,842

1/1/x2
Cash 120,000
Interest receivable 120,000

12/31/x2
Interest receivable 120,000
Investment in bonds 13,499
Interest income 133,499

1
2. Solution:
Interest Interest Present
Date received income Amortization value
1/1/x1 1,075,939
12/31/x1 120,000 96,834.51 23,165 1,052,774
12/31/x2 120,000 94,749.62 25,250 1,027,523
12/31/x3 120,000 92,477.08 27,523 1,000,000

3. C

4. D

5. D

6. B

7. A

8. A

9. Solutions:

Requirement (a):
Interest Interest
Date received income Amortization Present value
1/1/x1 907,135*
12/31/x1 100,000 126,999 26,999 934,134
12/31/x2 100,000 130,779 30,779 964,913
12/31/x3 100,000 135,088 35,088 1,000,000

* [827,135 + (1M x 80%)] = 907,135

Requirement (b):
1/1x1
Investment in bonds 907,135
Cash 907,135

12/31/x1
Cash 100,000
Investment in bonds 26,999
Interest income 126,999

12/31/x2
Cash 100,000
Investment in bonds 30,779
Interest income 130,779

2
12/31/x3
Cash 100,000
Investment in bonds 35,088
Interest income 135,088

Cash 1,000,000
Investment in bonds 1,000,000

10. Solution:
Interest Interest Present
Date received income Amortization value
1/1/x1 907,135
12/31/x1 100,000 126,999 26,999 934,134
7/1/x2 50,000 65,389 15,389 949,523

7/1/x2
Interest receivable 50,000
Investment in bonds 15,389
Interest income 65,389

Cash 900,000
Loss on sale of bonds 99,523
Interest receivable 50,000
Investment in bonds 949,523

11. B

12. Solutions:

Requirement (a):
The annual collections are computed as follows:
Date Principal Interest Collections
12/31/x1 1,000,000 (3M x 10%) 300,000 1,300,000
12/31/x2 1,000,000 (2M x 10%) 200,000 1,200,000
12/31/x3 1,000,000 (1M x 10%) 100,000 1,100,000

Date Collections Interest income Amortization Present value

1/1/x1 2,900,305
12/31/x1 1,300,000 348,037 951,963 1,948,342
12/31/x2 1,200,000 233,801 966,199 982,143
12/31/x3 1,100,000 117,857 982,143 -

Requirement (b):
1/1/x1
Investment in bonds 2,900,305
Cash 2,900,305

3
12/31/x1
Cash 1,300,000
Interest income 348,037
Investment in bonds 951,963

13. Solutions:

Requirement (a): Interest receivable

20x1: (100,000 x 10%) = 10,000

20x2: (100,000 + 10,000) x 10% = 11,000 + 10,000 from 20x1 = 21,000

Requirement (b):
Date Interest income Discount Present value
1/1/x1 IGNORED 94,738
12/31/x1 11,369 IGNORED 106,107
12/31/x2 12,733 IGNORED 118,839
12/31/x3 14,261 IGNORED 133,100

12/31/x1: (106,107 – 10,000 interest receivable) = 96,107

12/31/x1: (118,839 – 21,000 interest receivable) = 97,839

Requirement (c):
1/1/x1
Investment in bonds 94,738
Cash 94,738

12/31/x1
Interest receivable 10,000
Investment in bonds (squeeze) 1,369
Interest income 11,369

12/31/x2
Interest receivable 11,000
Investment in bonds (squeeze) 1,733
Interest income 12,733

14. Solution:

1/1x1
Investment in bonds - FVOCI 907,135
Cash 907,135

4
Amortization table
Interest Interest
Date received income Amortization Present value
1/1/x1 907,135*
12/31/x1 100,000 126,999 26,999 934,134
12/31/x2 100,000 130,779 30,779 964,913
12/31/x3 100,000 135,088 35,088 1,000,000

12/31/x1
Cash 100,000
Investment in bonds - FVOCI 26,999
Interest income 126,999

Investment in bonds – FVOCI 45,866

Unrealized gain – OCI 45,866
[(1M x 98%) – 934,134]

12/31/x2
Cash 100,000
Investment in bonds - FVOCI 30,779
Interest income 130,779

Fair value - 12/31/x2 1,020,000

Amortized cost - 12/31/x2 964,913
Cumulative balance of gain - 12/31/x2 55,087
Cumulative balance of gain - 12/31/x1 45,866
Unrealized gain (loss) - OCI in 20x2 9,221

Investment in bonds – FVOCI 9,221

Unrealized gain – OCI 9,221

12/31/x3
Cash 100,000
Investment in bonds - FVOCI 35,088
Interest income 135,088

Fair value - 12/31/x3 1,000,000

Amortized cost - 12/31/x3 1,000,000
Cumulative balance of gain - 12/31/x3 -

5
 Cumulative balance of gain - 12/31/x2 55,087
Unrealized gain (loss) - OCI in 20x3 (55,087)

Unrealized loss – OCI 55,087

Investment in bonds – FVOCI 55,087

Cash 1,000,000
Investment in bonds 1,000,000

15. Solution:

Interest Interest Present

Date received income Amortization value
1/1/x1 907,135
12/31/x1 100,000 126,999 26,999 934,134
7/1/x2 50,000 65,389 15,389 949,523

7/1/x2
Interest receivable 50,000
Investment in bonds - FVOCI 15,389
Interest income 65,389

Fair value - 7/1/x2 900,000

Amortized cost - 7/1/x2 949,523
Cumulative balance of gain - 12/31/x2 (49,523)
Cumulative balance of gain - 12/31/x1 45,866
Unrealized loss - OCI in 20x2 (95,389)

Unrealized loss – OCI 95,389

Investment in bonds – FVOCI 95,389

Cash 900,000
Loss on sale – P/L 99,523
Investment in bonds – FVOCI 900,000
Interest receivable 50,000
Unrealized loss – OCI 49,523*

*Unrealized gain (loss) - OCI

45,866 12/31/x1
7/1/x2 95,389
bal. (debit) 49,523

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PROBLEM 3: EXERCISES
1. Solutions:
Requirement (a):
Interest Interest
Date Amortization Present value
received income
1/1/x1 1,060,747
1/1/x2 140,000 127,290 12,710 1,048,037
1/1/x3 140,000 125,764 14,236 1,033,801
1/1/x4 140,000 124,056 15,944 1,017,857
1/1/x5 140,000 122,143 17,857 1,000,000

Requirement (b):
(1,033,801 - 1,000,000) = 33,801 premium

Requirement (c):
1/1/x1
Investment in bonds 1,060,747
Cash in bank 1,060,747

12/31/x1
Interest receivable 140,000
Investment in bonds 12,710
Interest income 127,290

1/1/x2
Cash 140,000
Interest receivable 140,000

12/31/x2
Interest receivable 140,000
Investment in bonds 14,236
Interest income 125,764

1/1/x3
Cash 140,000
Interest receivable 140,000

12/31/x3
Interest receivable 140,000
Investment in bonds 15,944
Interest income 124,056

1/1/x4
Cash 140,000
Interest receivable 140,000

7
12/31/x4
Interest receivable 140,000
Investment in bonds 17,857
Interest income 122,143

1/1/x5
Cash 1,000,000
Investment in bonds 1,000,000

2. Solution:
Interest Interest Present
Date Amortization
received income value
1/1/x1 1,937,951
12/31/x1 200,000 213,175 13,175 1,951,126
12/31/x2 200,000 214,624 14,624 1,965,749
12/31/x3 200,000 216,232 16,232 1,981,982
12/31/x4 200,000 218,018 18,018 2,000,000

3. Solutions:
Requirement (a):
Interest Interest
Date Amortization Present value
received income
1/1/x1 453,567*
12/31/x1 50,000 63,499 13,499 467,066
12/31/x2 50,000 65,389 15,389 482,456
12/31/x3 50,000 67,544 17,544 499,999

*(428,567 + 25,000) = 453,567

Requirement (b):
Interest Interest
Date Amortization Present value
received income
1/1/x1 512,656*
12/31/x1 50,000 46,139 3,861 508,795
12/31/x2 50,000 45,792 4,208 504,587
12/31/x3 50,000 45,413 4,587 499,999

*[487,656 + (500,000 x 5%)] =512,656

8
4. Solutions:
Requirement (a):
Interest Interest Present
Date Amortization
received income value
1/1/x1 2,096,073*
12/31/x1 280,000 251,529 28,471 2,067,602
12/31/x2 280,000 248,112 31,888 2,035,714
12/31/x3 280,000 244,286 35,714 2,000,000

* (1,996,073 + 100,000) = 2,096,073

Requirement (b):
1/1x1
Investment in bonds 2,096,073
Cash 2,096,073

12/31/x1
Cash 280,000
Investment in bonds 28,471
Interest income 251,529

12/31/x2
Cash 280,000
Investment in bonds 31,888
Interest income 248,112

12/31/x3
Cash 280,000
Investment in bonds 35,714
Interest income 244,286

Cash 2,000,000
Investment in bonds 2,000,000

5. Solution:
Interest Interest Present
Date Amortization
received income value
1/1/x1 2,096,073
12/31/x1 280,000 251,529 28,471 2,067,602
9/30/x2 210,000 186,084 23,916 2,043,686

9/30/x2
Interest receivable 210,000
Investment in bonds 23,916
Interest income 186,084

9
Cash 2,400,000
Interest receivable 210,000
Investment in bonds 2,043,686
Gain on sale of bonds 146,314

6. Solution:

1/1x1
Investment in bonds - FVOCI 2,096,073
Cash 2,096,073

Interest Interest Present

Date Amortization
received income value
1/1/x1 2,096,073*
12/31/x1 280,000 251,529 28,471 2,067,602
12/31/x2 280,000 248,112 31,888 2,035,714
12/31/x3 280,000 244,286 35,714 2,000,000

* (1,996,073 + 100,000) = 2,096,073

12/31/x1
Cash 280,000
Investment in bonds - FVOCI 28,471
Interest income 251,529

Unrealized loss – OCI 27,602

Investment in bonds – FVOCI 27,602
[(2M x 102%) – 2,067,602]

12/31/x2
Cash 280,000
Investment in bonds – FVOCI 31,888
Interest income 248,112

Fair value - 12/31/x2 2,080,000

Amortized cost - 12/31/x2 2,035,714
Cumulative balance of gain - 12/31/x2 44,286
Cumulative balance of loss - 12/31/x1 (27,602)
Unrealized gain - OCI in 20x2 71,888

Investment in bonds – FVOCI 71,888

Unrealized gain – OCI 71,888

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12/31/x3
Cash 280,000
Investment in bonds 35,714
Interest income 244,286

Fair value - 12/31/x3 2,000,000

Amortized cost - 12/31/x3 2,000,000
Cumulative balance of gain - 12/31/x3 -
Cumulative balance of gain - 12/31/x2 44,286
Unrealized loss - OCI in 20x3 (44,286)

Unrealized loss – OCI 44,286

Investment in bonds – FVOCI 44,286

Cash 2,000,000
Investment in bonds - FVOCI 2,000,000

7. Solution:
Interest Interest Present
Date Amortization
received income value
1/1/x1 2,096,073
12/31/x1 280,000 251,529 28,471 2,067,602
9/30/x2 210,000 186,084 23,916 2,043,686

9/30/x2
Interest receivable 210,000
Investment in bonds - FVOCI 23,916
Interest income 186,084

Fair value - 9/30/x2 2,400,000

Amortized cost - 9/30/x2 2,043,686
Cumulative balance of gain - 9/30/x2 356,314
Cumulative balance of loss - 12/31/x1 (27,602)
Unrealized gain - OCI in 20x2 383,916

Investment in bonds – FVOCI 383,916

Unrealized gain – OCI 383,916

11
Cash 2,400,000
Unrealized gain – OCI 356,314
Interest receivable 210,000
Investment in bonds 2,400,000
Gain on sale of bonds 146,314

8. Solutions:
Requirement (a):
The annual collections are computed as follows:
Date Principal Interest Collections
12/31/x1 300,000 (900,000 x 10%) 90,000 390,000
12/31/x2 300,000 (600,000 x 10%) 60,000 360,000
12/31/x3 300,000 (300,000 x 10%) 30,000 330,000

Date Collections Interest income Amortization Present value

1/1/x1 870,092
12/31/x1 390,000 104,411 285,589 584,503
12/31/x2 360,000 70,140 289,860 294,643
12/31/x3 330,000 35,357 294,643 0.61

Requirement (b):
1/1/x1
Investment in bonds 870,092
Cash 870,092

12/31/x1
Cash 390,000
Interest income 104,411
Investment in bonds 285,589

9. Solutions:
Requirement (a):
20x1: (2,000,000 x 12%) = 240,000
20x2: (2,000,000 + 240,000) x 12% = 268,800 + 240,000 from 20x1 =
508,800

Requirement (b):
Date Interest income Discount Present value
1/1/x1 IGNORED 2,111,086
12/31/x1 211,109 IGNORED 2,322,195
12/31/x2 232,219 IGNORED 2,554,414
12/31/x3 255,441 IGNORED 2,809,855

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12/31/x1: (2,322,195 – 240,000 interest receivable) = 2,082,195
12/31/x1: (2,554,414 – 508,800 interest receivable) = 2,045,614

Requirement (c):
1/1/x1
Investment in bonds 2,111,086
Cash 2,111,086

12/31/x1
Interest receivable 240,000
Investment in bonds (squeeze) 28,891
Interest income 211,109

12/31/x2
Interest receivable 268,800
Investment in bonds (squeeze) 36,581
Interest income 232,219

10. Solution:
Purchase price of bonds = Present value of future cash flows
Purchase price of bonds = ₱7,986,000 x PV of ₱1 @16%, n=3
Purchase price of bonds = ₱5,116,292 (7,986,000 x 0.640658)

11. Solution:
Interest PV of cash Interest Present
Date Amortization
income flow receivable value
(a) =ER x (b) = prev. bal. of (d) = (a) - = PV +
(c)
(b) (b) + (a) (b) (d)
1/1/x1 5,116,292 5,116,292
4/1/x1 204,652 5,320,944 150,000 54,652 5,170,944

Purchase cost of bonds ₱ 5,170,944

Purchased accrued interest (3M x 10% x 3/12) 150,000
Total purchase price or total cash outlay ₱ 5,320,944

OR, simply the PV of cash flow of ₱5,320,944 because this amount

already includes the purchased interest.

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PROBLEM 4: CLASSROOM ACTIVITIES

ACTIVITY #1:
Solutions:
Requirement (a):
1,000 face amount x 1,000 no. of bonds = 1,000,000

Requirement (b):
1,000,000 – 922,783 = 77,217 discount

Requirement (c):
Investment in bonds 922,783
Cash in bank 922,783

Requirement (d):
NIR = 8%

Requirement (e):
Trial & Error
PV = CF x PVF

There is discount. Therefore, the EIR must be higher than 8%.

First trial: @10% per annum (5% semi-annual)

➢ 922,783 = (1,000,000 x PV of 1 @ 5%, n=10) + (40,000 x PV

ordinary annuity @5%, n=10)
➢ 922,783 = (1,000,000 x 0.61391) + (40,000 x 7.72173)
➢ 922,783 = 613,910 + 308,869
➢ 922,783 approximates 922,779 (a difference of only ₱4.00)

Therefore, the EIR is 10% (per annum).

Requirement (f):
Interest Interest
Date received income Amortization Present value
7/1/x1 922,783.00
1/1/x2 40,000.00 46,139.15 6,139.15 928,922.15
7/1/x2 40,000.00 46,446.11 6,446.11 935,368.26
1/1/x3 40,000.00 46,768.41 6,768.41 942,136.67
7/1/x3 40,000.00 47,106.83 7,106.83 949,243.50
1/1/x4 40,000.00 47,462.18 7,462.18 956,705.68
7/1/x4 40,000.00 47,835.28 7,835.28 964,540.96
1/1/x5 40,000.00 48,227.05 8,227.05 972,768.01

14
7/1/x5 40,000.00 48,638.40 8,638.40 981,406.41
1/1/x6 40,000.00 49,070.32 9,070.32 990,476.73
7/1/x6 40,000.00 49,523.84 9,523.84 1,000,000.57

ACTIVITY #2:
Case #1:
Requirement (a):
7/1/x1
Investment in bonds 10,000.00
Interest income (Interest receivable) 116.67
(10,000 x 7% x 2/12)
Cash in bank 10,116.67

8/1/x1
If “Interest receivable” was debited on 7/1/x1:
Cash in bank (10,000 x 7% x 3/12) 175.00
Interest receivable 116.67
Interest income 58.33

If “Interest income” was debited on 7/1/x1:

Cash in bank (10,000 x 7% x 3/12) 175.00
Interest income 175.00

11/1/x1
Cash in bank (10,000 x 7% x 3/12) 175.00
Interest income 175.00

12/x/x1
Interest receivable (10,000 x 7% x 2/12) 116.67
Interest income 116.67

Requirement (b):
(10,000 x 7% x 6/12) = 350

Requirement (c):
(10,000 x 7% x 2/12) = 116.67

Requirement (d):
(175 + 175) see entries above = 350

15
Case #2:

Requirement (a):
Purchase price:
Cash flows PV Factors Purchase price
10,000.00 0.5584 5,584.00
700.00 7.3601 5,152.07
10,736.07
5/1/2000
Investment in bonds 10,736.07
Cash in bank 10,736.07

Requirement (b):
(10,000 x 7% x 8/12) = 466.67

Requirement (c):
Interest Interest Present
Date receivable income Amortization value
5/1/2000 10,736.07
12/31/2000 466.67 429.44 37.22 10,698.85

Carrying amt. 12.31.2000 10,698.85

Face amount 10,000.00
Premium 12.31.2000 698.85

Case #3:

Requirement (a):
Purchase price of bonds:
(10,000 x 1.07 x 1.07 x 1.07 x 1.07 x 1.07 x 1.07 x 1.07 x 1.07 x 1.07
x 1.07) = 19,671.51 x PV of 1 @8%, n=10 = 9,111.72

Requirement (b):
5/1/2000 to 5/1/2001 10,000 x 7% 700.00
5/1/2001 to 5/1/2002 (10,000 + 700) x 7% 749.00
Total Interest receivable - 5/1/2002 1,449.00

16
Requirement (c):
Date Interest income Discount Present value
5/1/2000 IGNORED 9,111.72
5/1/2001 728.94 IGNORED 9,840.65
5/1/2002 787.25 IGNORED 10,627.91

Carrying amt. of bonds and interest receivable 10,627.91

Less: Int. receivable as of 5/1/2002 (see ‘b’ above) (1,449.00)
Carrying amt. of bonds – 5/1/2002 9,178.91

PROBLEM 5: MULTIPLE CHOICE - THEORY

1. A 6. B
2. A 7. A
3. C 8. D
4. A 9. A
5. A

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PROBLEM 6: COMPUTATIONAL: MULTIPLE CHOICE
1. B (200K x 98%) + 700 = 196,700

2. B (500,000 x8% x 6/12) = 20,000

3. A (946,000 – 40,000) = 906,000 acquisition cost.

Interest Present
Date Collection income Amortization value
7/1/2003 906,000
12/31/2003 40,000 45,300 5,300 911,300

4. B
Solution:
Let us assume that the face amount is 100,000.
Face amount 100,000
Discount (10,000)
Purchase price 90,000
Subsequent amortization of discount 2,000
Carrying amount on date of sale 92,000

Face amount 100,000

Premium 14,000
Sale price 114,000
Carrying amount on date of sale (92,000)
Gain on sale 22,000

5. A
Solution:
Interest receivable
beg. 38,000
Interest revenue 160,500 152,000 Collections
46,500 end.

6. A

7. A
Solution:

Trial & Error

PV = CF x PVF

There is discount. Therefore, the EIR must be higher than 10%.

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First trial: @12% per annum

➢ 4,639,522 = (5,000,000 x PV of 1 @ 12%, n=5) + (500,000 x PV

ordinary annuity @12%, n=5)
➢ 4,639,522 = (5,000,000 x 0.56743) + (500,000 x 3.604776)
➢ 4,639,522 = 2,837,150 + 1,802,388
➢ 4,639,522 approximates 4,639,538 (a difference of only ₱16.00)

Therefore, the EIR is 12% (per annum).

Interest income in 20x1 = (4,639,522 x 12%) = 556,743

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