Amortization & Effective Interest Rate in a nutshell

Hi all!

 

Today, we’ll delve into amortization. Remember this: If an instrument has no principal and coupon repayments, it falls under the FVTOCI (Fair Value Through Other Comprehensive Income) category because it’s an irredeemable instrument. On the other hand, if redemption is mandatory but interest payments are not periodic, those instruments are classified as FVTPL (Fair Value Through Profit or Loss) instruments. For amortization instruments, it’s essential that they pass the SPPI (Solely Payments of Principal and Interest) test.

Here are few examples

Issued at: PAR

Redeemed at: PAR

 

Issued at: DISCOUNT

Redeemed at: PAR

 

Issued at: PREMIUM

Redeemed at: PAR

 

Issued at: PAR

Redeemed at: PREMIUM

 

Issued at: PREMIUM

Redeemed at: PREMIUM

 

Issued at: DISCOUNT

Redeemed at: PREMIUM

 

Observing the amortization process, it’s essential to recognize that the Effective Interest Rate (EIR) doesn’t necessarily align with the initial derivation from XIRR, IRR, or manual formula. Consequently, I’ve adjusted it using goal seek to ensure the closing balance reaches zero.

In the context of consolidation, when intragroup financing occurs without issue costs, the finance charges from both parties align. This is because the effective interest rate (EIR) remains consistent. 

Lastly, like to mention that I’ve calculated the redemption value based on the issue price rather than the face value. This corresponds with my private contract, recognizing that banks may follow a different approach, I invite you to try redemption value on face value. View/Download Excel file.

 

Feel free to reach out if you have any further questions or need assistance! 😊

 

Disclaimer: Please note that the methods I’ve employed here are not publicly documented or found in professional literature, except for principles related to issue costs. I encourage you to grasp the underlying concepts. However, I do not assert any authority over the policies relevant to lender and borrower amortization reconciliation, as these remain undisclosed or rather asymmetric. My approach relies on accounting conventions to the best of my ability.

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