Discussion Questions
What are the key features of a bond?
What are the key features of a bond? What is interest rate risk? Which bond has more interest rate risk, an annual payment 1-year bond or a 10-year bond? Why?
What factors determine a company’s bond rating?
Finish those question, and write comments for three people.
1st person
The key features of a bond are maturity, par value, coupon rate, bond rating, and provisions.
Maturity is the date that bond is to be paid out by the issuer of the bond. This includes the interest amount earned on the bond.
Par value is that value of the bond or the face value as stated on the bond.
The coupon rate is also known as the interest rate of the bond or how much the bond will pay out over the Par value.
The bond rating is the risk assessment of the issuer of the bond. The higher the rating of the bond the lower the interest rate will be and the lower the rating the higher the interest rate.
Provisions are placed on bonds as protection in case of fluctuating markets. Some bonds have callable provisions that allow the issuer to recall a bond and the same can be said for bondholders a protection provision may be placed on the bond to protect those holders from having their bonds called back.
Interest rate risk or also known as price risk is when bonds lose their value due to an increase in interest rates.
The 10-year bond will have more risk as opposed to a 1-year bond due to the longer time frame for the maturity date.
One of the biggest factors that go into a company’s bond rating is creditworthiness or credit risk. This is the company’s ability to pay the bond when it reaches maturity. Companies that demonstrate a higher level of creditworthiness will have a higher rating that will lower the interest rate on the bonds they issue.
Another factor is future performance. The bond raters will look at a company’s history and potential future markets through research to determine how a company will perform. This could cause the company to have a high or low rating depending on what is projected in the future.
Lastly are upcoming known company projects. If a company is known to be working a large project that could potentially increase profits the companies bond rating may increase. The same goes for a poor release of a finished product could cause the companies bond rating to decrease.
2nd person
A few key features of a bond would be maturity, par value, coupon rate, call provisions, and currency denomination.
Maturity is the time at which the bond matures and the holder receives the final payment of principal and interest.
Par Value is the dollar amount the holder will receive at the bond’s maturity… Par value is also known as principle, face, maturity or redemption value. Bond prices are quoted as a percentage of par.
Coupon Interest Rate states the interest rate the bond will pay the holders each year. The rate is for one year and payments are usually made on a semi-annual basis. Some asset-backed securities pay monthly, while many international securities pay only annually. The coupon rate also affects a bond’s price. Typically, the higher the rate, the less price sensitivity for the bond price because of interest rate movements.
Call Provision in a bond contract that gives the issuer the right to redeem the bonds under specified terms prior to the normal maturity date
Currency denomination indicates what currency the interest and principle will be paid in
Interest rate risk is the possibility that the value of an investment will decline as the result of an unexpected change in interest rates. This risk is most commonly associated with an investment in a fixed-rate bond. When interest rates rise, the market value of the bond declines, since the rate being paid on the bond is now lower in relation to the current market rate
10 year bond has more price risk, the longer the maturity, the greater the change in value for a given change in interest rates.
A few factors that determine a company’s bond rating would be;
Cash Flow Predictability- A reduction in an issuer’s cash flow will drastically limit its ability to make interest and principal payments. Ratings analysts look at the issuer’s operating budgets and forecasts. In the case of government issuers, they look at spending and revenue plans, such as future tax revenues and pension obligations.
Adverse Scenario- A ratings agency estimates each issuer’s response to a selection of possible future scenarios, both at the broader macroeconomic level, such as a rise in interest rates or a recession, and at a level more specific to the individual issuer, such as losing key clients or the entry of a new competitor to the field. The ratings agency calculates the probability of each scenario, and the degree to which each will affect the issuer’s ability to meet its bond payment obligations.
Default Severity- ratings include an estimate of the probability of default on debt, and of the expected loss in the case of default. An issuer may pay some of its obligations but not all, so the expected loss may be less than 100 percent of its debt, or it may mean late payments rather than no payment at all. Sector specific takes a closer look at sector-specific risks and scenarios. This may include assessing demographic trends or understanding the effect of future regulatory changes on the industry. For example, a wide, sweeping change in financial market regulation will affect all issuers in the sector, and, depending on the role of the company being rated, may be positive or negative.
Insider Information- Ratings agencies often rely on insider information to determine the financial outlook for a particular company. Analysts cannot disclose the details, but they can use the information for the purposes of rating. It may be in a company’s best interests to let Moody’s or Standard & Poor’s know about big upcoming deals if it means a better rating and a lower interest rate when they issue debt to finance new projects.
Monitoring- Factors such as changes in company policies, the general economy, and demographic shifts constantly influence an issuer’s financial situation. Ratings agencies monitor key developments and watch for situations affecting future creditworthiness. When a change is large enough, an agency may issue a revised credit rating. An improvement in the rating will result in lower interest rates on debt, as well as a change in price on any debt already issued. If a credit rating falls, interest rates will increase on both current and future debt.
3rd person
What are the key features of a bond?
Bonds have five key characteristics which are par value, coupon interest rate, maturity date, call provisions and sinking funds. The stated face value of a bond is known as par value. Par value is the amount of money that a company borrows and agrees to repay on the maturity date. Coupon Interest Rate is a fix number of payments of interest that a company must pay each year. This rate is set at the time of the bond and is effective throughout the life of the bond. Maturity date is the date that the par value must be repaid by. Most maturities have original maturities which exists at the time that the bond is issued. An issuer’s right to call the bond for redemption is known as the call provision. Issuers are required to pay bondholders an amount of money that is more than the par value. A provision that is known to facilitate the orderly retirement of the bond issue is known as the sinking fund provision.
What are the key features of a bond? What is interest rate risk? Which bond has more interest rate risk, an annual payment 1-year bond or a 10-year bond? Why?
An interest rate risk is also known as a price risk and occurs when an interest rate increases causing a decline in the value of a bond. The 10-year bond will have a higher interest rate risk than a 1-year bond because interest rate risks are higher on bonds that have longer maturity dates.
What factors determine a company’s bond rating?
Financial ratios related to a company’s credit or financial risk can help determine its bond rating. Ratios that are related to financial risk is a major factor. Bond contract terms is another factor that can determine a company’s bond rating. Exposure to subprime loans and future performance are more factors that help determine the bond rating of a company. Company events that are positive can determine the bond rating of a company and increase the bond rating while a negative company event will decrease the bond rating of a company.
Solution Preview
I agree with the first person in his essay on the critical features of a bond. Some of the key elements of a bond are maturity which is termed as the time at which the bond matures hence the holder receives the final payment. Another critical factor is par value which is the dollar amount received by the holder at the bonds maturity.
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