spaghettios wrote:
@Krok - I am having trouble hacking through this whole reading. Do you think it’s worthwhile to go back to L1 to help? Or is it just about learning rules.
Also, in the curriculum i see a lot of rules (i.e. “if … this then …use this method” etc.) but not many examples of calculations, for example calculating interest and the amortised cost. Is it mainly just about knowing which rules to use under given circumstances?
Apologies if the second part sounds stupid, i haven’t completed the reading.
Yeah, Intercorp Investments is very rules based.
For HTM securities, the key principal is understanding what is hitting Profit and Loss, and how carrying value may need to be adjusted.
Profit and Loss is easy, as it’s simply the coupon payment.
Carrying value is based entirely on whether the debt security was purchased at par (no adjustment needed), a premium (amortize the premium down) or a discount (amortize the discount up). If the security was purchased at a premium, it means the YTM on the bond was lower than the coupon rate when purchased. A higher coupon than the YTM will reduce the premium towards par over the remaining term of the bond. Vice versa when purchased at a discount.
So for example (using Wiley’s simple example on the effective interest rate method):
A bond is purchased for $240,000 which has a 7% coupon and $200,000 par value (purchased at a $40,000 premium). The market interest rate (YTM) when the bond was purchased was 5%. In the following year:
Beginning carrying value = $240,000
Coupon Payment received = $200,000 x 7% = $14,000
Interest income = $240,000 x 5% = $12,000
Amortization of premium = $14,000 - $12,000 = $2,000
So, carrying value at the end of the first year is $240,000 - $2,000 = $238,000
If the bond was purchased at a discount, interest income would be higher than the coupon, and you would add the difference to the beginning carrying value (heading up towards par).
Hope that helps!