1. Treasury Management Software Reporting Discounts and Premiums CMTA Education Conference Cal Poly, Pomona September 28-30, 2010 Peter Bakonyvari Director of Sales

2. ©2010 by Emphasys Software. All Rights Reserved. Definition of a Premium or Discount Premium: The excess amount paid for a fixed income coupon security, excluding purchased interest, over the par or face value. Principal paid – par or face value = premium $1,020,000 - $1,000,000 = $20,000 Discount: The principal paid under par or face value of a fixed income coupon security, excluding purchased interest. Par or face value - amount paid = discount $1,000,000 - $980,000 = $20,000 Discount Note: No coupon payments, matures at par.

3. ©2010 by Emphasys Software. All Rights Reserved. Why are there Premiums and Discounts Why: Security coupon is more or less than the market rate Issuer Risk – risk of principal repayment Premium scenario: If the market is yielding 2% and the security is paying 3%, then you would have to pay more than par value for the security. The premium would reduce the yield of the security to equal the current market yield (2%). Discount scenario: If the market is yielding 2% and the security is paying 1%, then you would pay less than par value for the security. The discount would increase the yield of the security to equal the current market yield (2%).

4. ©2010 by Emphasys Software. All Rights Reserved. Two Basic Accounting Methodologies Cash Basis: When using cash basis, interest income accrues daily and capital gains and losses are recognized as they occur or are received. A capital gain or loss occurs when an investment is either sold (full or partial), called, or matured. The capital gain or loss is the difference between the purchased principal and principal sold (for a sale or call) or par/face value (for a maturity) Accrual Basis: When using accrual basis, interest income accrues daily and adjustments are made to accrued interest for amortization which results in net investment income. The daily amortization component is used to adjust the book value of the investment. Capital gains and losses on sales (full or partial) and calls are calculated as the difference between the book value of the investment at the time of sale and the principal sold. There will be no capital gain or loss on an investment held to maturity as it has been fully amortized.

5. ©2010 by Emphasys Software. All Rights Reserved. How do I account for my Premiums and Discounts? Cash Basis: Premium/Discount: Realize the premium or discount at time of redemption as a gain or loss. One lump sum. Redemption value - Purchase principal = gain/loss Premium You purchase a bond for $1,020,000 with a 2% coupon that matures in 3yrs at par ($1,000,000). At maturity, I would receive a $1,000,000 and account for $20,000 as a loss (the amount of the premium). Discount You purchase a bond at a discount of $980,000 with a 2% coupon that matures in 3yrs at par ($1,000,000). At maturity, I would receive a $1,000,000 and account for $20,000 as a gain (the amount of the discount).

6. ©2010 by Emphasys Software. All Rights Reserved. Accrual Basis: Premium/Discount: Recognize a portion of the premium or discount over the life of the investment or to a call date (accelerate recognition). If there is an early redemption (sale or call) and a portion of the premium or discount still remains, you would recognize a gain or loss at time of redemption. Premium You purchase a bond at a premium for $1,020,000 with a 2% coupon that matures in 3yrs at par ($1,000,000). Each month you would account for $555.55 in premiums ( $20,000 / 36 mo. = $555.55). At maturity, I would receive a $1,000,000. Discount You purchase a bond at a discount of $980,000 with a 2% coupon that matures in 3yrs at par ($1,000,000). Each month you would account for $555.55 in discounts ( $20,000 / 36 mo. = $555.55). At maturity, I would receive a $1,000,000.

7. ©2010 by Emphasys Software. All Rights Reserved. CashAccrual Monthly recognition of Prem/Disc No Yes Book Value Adjustments No Yes Gain/Loss at maturity Yes No Gain/Loss on early redemption Yes Maybe Effects monthly returns No Yes Monthly returns on premium bonds Higher Lower Monthly returns on discount bonds Lower Higher More control of Prem/Disc recognition No Yes More accurate recog. of monthly earnings No Yes Potential large swings in portfolio returns Yes No Premiums and Discounts How do they affect your reporting

8. ©2010 by Emphasys Software. All Rights Reserved. Debit Credit Purchase Investments1,020,000.00 Cash1,020,000.00 Monthly Transaction Investments 0.00 Earnings 0.00 Redemption or Maturity Investments1,020,000.00 Cash1,000,000.00 Capital Gain/Loss 20,000.00 Cash Basis Journal Entries

9. ©2010 by Emphasys Software. All Rights Reserved. Accrual Basis Journal Entries Debit Credit Purchase Investment1,000,000.00 Premium 20,000.00 Cash1,020,000.00 Monthly Transaction Premium 555.56 Amortization Expense 555.56 Redemption or Maturity Investments1,000,000.00 Cash1,000,000.00

10. ©2010 by Emphasys Software. All Rights Reserved. Reporting through Software Solutions Reporting your Premiums and Discounts Interest Earnings Capital Gains and Losses Effective Rate of Return Amortization Schedule

11. ©2010 by Emphasys Software. All Rights Reserved. Should I ever buy at a Premium? Things to consider How long will you hold the security Coupon rate – do I have enough cash flows to cover premium Call features Portfolio liquidity Are you willing to pay more for safety Your investment policy Difficulty in accounting for security Political situation