Assume a Company Has One Asset, a B Company Bond

Assume A Company has one asset, a B Company bond that Company A purchased on the date of issuance by Company B, and one liability, one of its own bonds issued to finance the acquisition of the B Company bond. Both bond have the same terms: $1,000 face value, 20-year life, and a 12% coupon rate, with interest being paid annually. Both bonds were issued at the market rate of interest of 12%.
Both A Company and B Company have elected to apply the fair value option for their respective bonds as allowed under the provisions of Statement of Financial Accounting Standards No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities--Including an amendment of FASB Statement No. 115."
Required:
Assume that the market rate of interest associated with both bonds decreased to 10%.
1. Explain what the financial effects this change in interest rate would have on both
companies if both companies applied the FASB's fair value option. Show
calculations to support your answer.
2. Assume now that A Company is required to report the bond asset at its fair value
of $1,261, but is also required to report the bond liability at its historical issuance
amount of $1,000.

Correct Answer:

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1.
The value of both bonds at the date o...

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