FINE 2000 Chapter Notes - Chapter 5: Liquidity Premium, Real Interest Rate, Nominal Interest Rate

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24 May 2012

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Then companies need money to make long-term investments they issue bonds, which are simply long- term loans. When companies issue bonds, they promise to make a series of fixed interest payments and then to repay the debt. As long as the company generates sufficient cash, the payments on a bond are certain. In this case bond valuation involves simple straight-forward time value of money computations. However, investors take default risk into account when they price the bonds and demand a higher interest rate to compensate when risk is higher. Companies raise capital to finance long-term investments by issuing bonds to investors. The money they collect when the bond is issued, or sold to the public, is the amount of the loan. In return, they agree to make specified payments to the bondholders, who are lenders. Coupon: the interest payments paid to the bondholders each year until the bond matures. Face value: payment at the maturity of the bond.

Related Questions

I NEED HELP WITH A RESPONSE TO THE POSTBELOW.

How do bonds provide financing to corporations for theircapital projects? Issuing bonds is the easiest mosteffective way to raise money to do the things needed to allow thecompany to grow without taking a loan from the bank with higherinterest rates. A investor basically loans the company the money inexchange for interest payments. Companies are more willing to issuea bond and pay a lower interest rate.

What are the key differences between using bonds tofinance capital projects and using stock for that purpose?The key difference is that with bonds companies can continue toissue all the bonds that they want just as long as they haveinvestors who are willing to invest the money for a certaininterest rate. When a company does this it does not have any impacton ownership and the way the company is operated or the sharesdistributed. With stocks you have to put up shares of the company,which will mean that the company brings in less money because ofthe sharing of the revenue with the stockholders of thecompany.

References

Smith, L. (2018, December 21). Why Companies Issue Bonds.Retrieved January 14, 2019, fromhttps://www.investopedia.com/articles/investing/062813/why-companies-issue-bonds.asp

The value of a bond is dependent primarily on twofactors. Name and explain these factors. The value of abond is dependent on the value of its cash flow in terms of thepresent value of the coupon payments and the present value of thepar value. The coupon changes according to the current interestrate. When the interest rate falls lower than the coupon rate thenthe value of the bond payment rises. The length of paymentsremaining before maturity is also a factor as it represents agreater or lesser portion of the value. The current value of a bondis always measured against the going interest rate, whichdetermines what will be paid out.

Compare and contrast the differences between stocks andbonds. The characteristics of bonds is that the valuerises and falls depending on interest rates, interest payment aretax deductible by the corporation, equity is not lost throughissuance, unpaid debt is a liability, can be issued at any time forany reason and the creditors have not voting powers. Thecharacteristics of stocks is that the value rises and fallsdepending on the value that the stock trades are at, dividends arenot tax deductible, loss of stock value creates no liability, canonly be issued one time, equity owners can control the company withvoting powers and stock issuance is based on transfer ofequity.