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TimeValue Software Blog

Constant Yield Method for Bond Amortization

By Martel Pellerin

TValue software is an excellent tool to calculate the discount or premium amortization of a bond. The Internal Revenue Service requires you to use the “constant yield method” to amortize bond premiums or discounts, which is the excess or discount of the bond price over face value. You pay the bond price and, if you hold the bond until maturity, you receive the face value. This creates a loss or gain, but you can’t deduct the loss or gain all at once. Instead, you amortize the bond over its remaining lifetime to expense part of the loss or book income each year. The amortized amount reduces or increases the interest income you receive for investing in the bond.

Constant Yield Method - The first step is to determine your yield to maturity, which is the discount rate that equates the present value of the bond to the price you paid. You need a financial calculator such as TValue to determine the yield from the following variables, bond interest rate, face value, price, and years to maturity. You will need to determine an “accrual period,” which is how long you accumulate amortization before recognizing it as an expense. The accrual period is normally equal to the time interval between interest payments. Once you have that information, you’re now ready to calculate the amortization for the period.

Using TValue, you will want to change the year length to 360 days. Your compounding period will match the cash flows, i.e. quarterly, semi-annual. You will enter a Loan event for the price paid for the bond. Then, you will enter the actual cash flows from the bond. These would be normal Payment events, whether they are interest only or principal plus interest on the coupon dates. Finally, enter a Payment for the value of the bond at maturity. These events represent the actual cash flows. Please note, you may have to input the original bond in TValue to get the cash flows to input to do the amortization of the premium or discount.

Now that you have entered the price paid and the actual cash flows, type “U” for the Nominal Annual Rate and click Calculate. The result is the actual yield of the bond. The amortization schedule will show you the amortization of the premium or discount from the principal column. If you need any help with these calculations, please give TimeValue Software Support Team a call at 800-426-4741.