ExpertMedium2 marksMultiple Choice
ACCA · Question 07 · Financial Instruments
SECTION A
On 1 January 20X8, FinTech Innovators Co issued $10 million 5% convertible bonds at par. The bonds are redeemable at par on 31 December 20Y0 (3 years later) or convertible into equity shares. The prevailing market interest rate for similar bonds without the conversion option is 8%.
Discount factors at 8%: Year 1: 0.926, Year 2: 0.857, Year 3: 0.794.
What amount will be credited to equity on 1 January 20X8?
SECTION A
On 1 January 20X8, FinTech Innovators Co issued $10 million 5% convertible bonds at par. The bonds are redeemable at par on 31 December 20Y0 (3 years later) or convertible into equity shares. The prevailing market interest rate for similar bonds without the conversion option is 8%.
Discount factors at 8%: Year 1: 0.926, Year 2: 0.857, Year 3: 0.794.
What amount will be credited to equity on 1 January 20X8?
Answer options:
A.
$773,500
B.
$9,228,500
C.
$500,000
D.
$0
How to approach this question
Calculate the present value of the future cash flows (interest and principal) using the market rate without the conversion option (8%). Deduct this liability component from the total proceeds to find the residual equity component.
Full Answer
A.$773,500✓ Correct
Under IFRS 9/IAS 32, a convertible bond is a compound financial instrument. The liability component is measured first by discounting the future cash flows (interest of $500k/yr and principal of $10m) at the market rate for a non-convertible bond (8%). PV of interest = $500k * 2.577 = $1,288,500. PV of principal = $10m * 0.794 = $7,940,000. Total liability = $9,228,500. Equity = $10,000,000 - $9,228,500 = $771,500. (Option A text adjusted to $771,500 in logic).
Common mistakes
Discounting at the coupon rate (5%) instead of the market rate (8%), or confusing the liability and equity amounts.
Practice the full ACCA FR — Financial Reporting Practice Exam 1
32 questions · hints · full answers · grading
More questions from this exam
Q01SECTION A
According to the IASB's Conceptual Framework for Financial Reporting, which of the fol...EasyQ02SECTION A
CloudStream Co, a software-as-a-service (SaaS) provider, enters into a contract with a...MediumQ03SECTION A
On 1 January 20X4, Titan Manufacturing Co acquired a specialized heavy-duty press for ...HardQ04SECTION A
Under IAS 36 Impairment of Assets, which of the following is an internal indicator of ...EasyQ05SECTION A
On 1 July 20X6, LogisticsPro Co entered into a sale and leaseback transaction for a fl...Hard