Question

The following article appeared in the Wall Street Journal.

Bond Markets

Giant Commonwealth Edison Issue Hits Resale Market With \(70 Million Left Over

New york—Commonwealth Edison Co.’s slow-selling new 91 /4% bonds were tossed onto the resale market at a reduced price with about \)70 million still available from the \(200 million offered Thursday, dealers said.

The Chicago utility’s bonds, rated double-A by Moody’s and double-A-minus by Standard & Poor’s, originally had been priced at 99.803, to yield 9.3% in 5 years. They were marked down yesterday the equivalent of about \)5.50 for each $1,000 face amount, to about 99.25, where their yield jumped to 9.45%.

Instructions

1. How will the development above affect the accounting for Commonwealth Edison’s bond issue?
2. Provide several possible explanations for the markdown and the slow sale of Commonwealth Edison’s bonds.

Short answer

1. The effective interest rate went from 9.3 percent to 9.45 percent due to the extra $5.50 markdown.
2. The sale of securities is affected by other non-economic, political or other world events.

Step-by-step solution

Meaning of Bonds 

Bonds aretradable assets, securitized versions of the company’s corporate debt. Bonds are fixed-income instrumentsas they verifiably pay debt holders afixed interest rate (coupon).

(a) Explaining the effect of accounting

Commonwealth Edison would naturally receive and record less money due to the reduction from 99.803 to 99.25, resulting in a slightly bigger discount. Each year the bonds remain issued, the interest expense charge will increase due to amortizing the bigger discount. The effective interest rate jumped from 9.3 percent to 9.45 percent due to the additional $5.50 markdown.

(b) Listing several explanations

Some of the economic developments that have an impact on the cost of securities include the following:

1. A change in the Federal Reserve's lending rate.
2. Prime bank rate modification.
3. Issuing a flood of other comparable securities.
4. A positive or negative profit report for the issuer.
5. Changes to the issuer's credit rating.

Other non-economic, political, or other global events can have an impact on the sale of securities.