1. In 2019, Jones Company invested in corporate bonds with an S&P credit rating of "B" - i.e. junk bonds. The bonds had a face value of $100,000, and a semi-annual coupon rate of 6%. Interest is payable every June 30^th and December 31^st. At the end of 2020, these bonds had a fair value of $101,000.

In 2022, however, interest rates rose and the bond market experienced a severe downturn. Junk bonds were especially hit hard. The activity in the junk bond market significantly declined and the bid-ask spread was 10X larger than its norm. In reviewing the transactions that are taking place, you find that the price is exorbitantly low - 10 cents on the dollar of face value. Current sellers are companies that have severe cash flow problems and had to sell to have the cash to meet payroll. While the situation in 2022 is the most extreme that you have ever seen, previous downturns in the junk bond market suggest an appropriate market rate of interest (discount rate) for a market similar to 2022 should be around 20%. The bonds have a remaining useful life of ten years.

Required:

You need to determine a fair value estimate for the junk bond investments at December 31, 2022. Discuss how you would go about doing this. Do not focus on calculating an amount, rather focus on the process to be followed to address the issues above. Be sure to include citations from FASB's codification to support your discussion.

Answer rating: 100% (QA)

Answer Determining Fair Value of Junk Bonds in a Depressed Market 2022 Jones Company needs to estimate the fair value of its junk bond investment at December 31 2022 Due to the depressed market and li... View the full answer