 In this presentation, we will take a look at the bonds market rate versus contract rate. Support accounting instruction by clicking the link below giving you a free month membership to all of the content on our website broken out by category further broken out by course. Each course then organized in a logical, reasonable fashion making it much more easy to find what you need than can be done on a YouTube page. We also include added resources such as Excel practice problems, PDF files and more like QuickBooks backup files when applicable. So once again, click the link below for a free month membership to our website and all the content on it. Remember that the bond is going to be similar to a note is basically a type of note. But there's a difference between a normal note that we get from a bank and the bond. The note that we get from the bank, we will typically adjust with our market negotiation when we're negotiating over the terms of the note. The thing that we usually negotiate is the interest amount. When we're getting a loan from the bank, for example, we want a hundred thousand dollar loan from the bank, then we're going to haggle over the interest on the 100,000. What rate of interest are we going to have to pay back in a bond? However, if the bond has already been made, then we cannot change the interest rate and we can't change the amount of the bond. They're already made. So then the question is, well, how can we trade this bond if the market rate of interest is different, the contract rate here being different than the market rate? Well, we can't change the rate. So what we can do is we could sell the bond for more or less than the face amount of bond. So remember what a bond means. It means just like a note, it says, you know, we're going to get so much money now and we're going to pay it back in the future, whatever term of the bond is, whatever the maturity date of the bond is, plus we're going to pay some type of interest on it. Now typically, if we got a hundred thousand dollar note, we would then pay back the hundred thousand at the end of the note, at the end of the loan, plus any interest on it. This is not the only way that this could work, however. We could, of course, say that we're going to accept something other than a hundred thousand now and we're going to pay you back one hundred thousand in the future. In other words, we may say give us a hundred one thousand now and we'll pay you back one hundred thousand at the end of the maturity date of the maturity date of the bond or pay us something less than a hundred thousand now and we'll pay you back a hundred thousand at the maturity date. Why would you do that? Why would anybody accept that because of the difference in interest rates? The difference is going to be made up by the fact that the market rate is currently different than the rate that's stated here on the bond. So what would that look like? Well, that's going to give us three types of options within a bond. The first one's going to be the easiest option and that's where the contract rate is going to be equal to the market rate. So if the contract rate is equal to the market rate, then we can just issue the bond with no discount and no premium, meaning it's going to be very similar to just a normal loan type of transaction because the rate that is stated on the bond is, in essence, correct. You can think of it as being exactly what the market rate is. This would only happen if we issued the bond right at the same time we made the bond and issued it. If there's a time delay between the creation of the bond and the issuance of the bond, it's more likely that the contract rate on the bond will not match the market rate. These other two scenarios, which could be that if the contract rate, the rate on the bond, it's printed on the bond, is greater than the market rate. And remember that the market rate is kind of an unknown. We know the market based on the market, what other things are doing, what other securities are doing, which are similar to this security. And therefore, so this isn't printed anywhere, in other words. The contract rate is on the contract, it's on the bond. So if the contract rate is greater than the market rate, that would mean that the bond is a good deal. So if we had a $100,000 bond, and we're going to say that the contract rate on our bond, we're paying more interest than other types of bonds are in a similar situation within the current market situations, therefore, we're going to issue the bond for a premium, meaning if we have a $100,000 bond and we have interest on the bond at 10% that we're paying, and the market rate for similar bonds is only 5%, then we're not just going to sell the bond for $100,000 because we're paying a lot more in interest. We can't change the percentage rate to 5% because it's already printed on the bond. What we can do is say that we're going to sell you the bond for something over $100,000. And therefore, we'll take more than $100,000 now, we'll make up the difference by paying you more in interest in the meantime, and then we'll just give you the $100,000 back at the end. The other possibility is that the contract rate is less than the market rate. So remember that the contract rate is printed on the bond. The market rate is something that just we assume or we figure out what the market is currently doing. So this is an actual rate written down. This rate is what we think the market rate is based on what other securities in a similar area are doing at the current time. So if this is the case, then we're going to contract where the rate on our contract is paying less than the market rate. And what that would mean is that if we couldn't change the rate, if we couldn't change anything, no one would give us money for our bonds because we wouldn't be able to sell them because they can go somewhere else, give the same amount of money if we had a $100,000 bond and they put the $100,000 into our bond, they would get less earnings, less interest than they could going elsewhere. We can't change the interest rate. We can't increase. We can't say, hey, we'll pay you more because it's already printed on the bond. The face amount and the interest are already on the bonds. What can we do then? Well, we can say we'll accept something less than $100,000 and issue the bonds at a discount. So we'll say, yeah, we're going to give you $100,000 at the end of the bond, but we'll accept something less than $100,000 now. We'll pay back $100,000 at the end. We'll accept something less than $100,000 now. Why? Because the interest we're going to pay you during the time period is a little bit less than the current market rates are. And therefore, that will make up the difference between the amount that we're going to receive now and the amount that we're going to give back at the end. Note that when we talk about a loan, on the other hand, the loan, the thing we negotiate on is the market rate. We're going to say, OK, we want $100,000, and we'll negotiate on the amount of interest we're going to pay back. The amount of earnings you're going to get on the $100,000. Because here, again, on the bonds, we can't adjust the rate to agree with the market rate. We can't adjust the contract rate to agree with the market rate. The bonds have already been produced. Therefore, the thing that we can change will be the amount of money we will receive at the front end for the bonds and then make up the difference between the difference and the rates through issuing the bond at a premium or a discount. So just note that these premiums and discounts, then, are a result of this difference between the rates, a result of the difference between the true rate, the market rate, and the rate that's on the bond, the contract rate. So when we deal with these premiums and discounts in the future, how are we going to account for them? I mean, they're going to have to go away as the bond is paid off. They're going to relate to interest, meaning we're going to be reducing the premium and discount and recording it to the other side, the income statement account of interest income as the bond is going through the process towards maturity as interest payments are made.