Bonds

Importance of bonds

            Various companies mainly issue the bonds to borrow money to the public. The bonds usually refer to a written and sighed promise certain amount of money on a specific date. This therefore implies that the bond can be seen as a way in which the public loan their money to the company where the company promises to pay after a certain date. However, most of the bonds also do pay a certain interest after certain period. The following are some of the major function of the bonds.

Preserving the principal amount

            The bonds are mainly used to preserve the principal amount of money. This is because the bonds are essentially loans that have secured repayment period. Various investors use the bonds therefore as way to ensure that their principle amount is secured.

Saving

            The bonds act as form of saving to the investors. This is because by the end of the agreed period the company returns the principal amount invested. In addition, this therefore implies that the bonds can provide an alternative ways in which the investor can save their money for future use.

Raising money

            Various companies mainly sell the bonds in order to finance their projects and business (Brigham, & Houston, 2009). This therefore implies that the bonds act as a way in which the companies get their capital from the public. In addition this also implies that the bonds help in ensuring that the company has enough capital and therefore they do not have to issue the shares in the stock market.

Diversification

            In relation to this the bonds help to diversify the market since they help to ensure that the investors have many options to invest their money. In addition, the bonds also help to act as an alternative source of income for the investors.

Importance of rating bond

Bonds rating refer to the act of giving the credit to the bonds. The bond rating therefore reflects the probability of a bond going to default (Brigham, & Ehrhardt, 2011).  The bond ratings are mainly based on the quantitative and qualitative factors, which include.

Financial ratios

            The major ratio used in the bond rating the return on asset debit ratio. The other types of ratio that can be used in the bond rate include the debt ratio (Brigham, & Ehrhardt, 2011).

Bond contract terms

            The bond contract terms are also used to assign the rates to various types of bonds. In relation to this the bond are normally assigned rating depending on the whether the bond is secured on the mortgage or using specific assets. The guarantee by other party provision may also be used during bond rating. In addition any sinking funds provision may also be used to assign rate to the bonds.

Qualitative factors

            The qualitative factors may also be used to carry out bond rating. In relation to this the sensitivity of the firm earning of the firm earning in the economy  may also be used to rate a particular bond used by the company. The probability of the firm to affected by the inflation may also be used to rate the bond since it indicate the stability of the firm. In addition the probability of a firm to have labor problems may also be used to rate the bonds issued by various companies. Other factors that may also be considered during bond rating include the potential environmental and antitrust problems (Brigham, & Ehrhardt, 2011).                                     

Why bonds change in value over time

            The bond prices usually moves inversely with the interest rates. This therefore implies that the prices of the bonds usually go up when the interest rates go down (Besley & Brigham, 2008). On the other hand when the interest rate of the bond goes up the prices of the bond usually goes down. One of the major reasons why the bonds fluctuate is the fact that the bonds usually offer a certain interest that is higher than the interest rates offered by the money borrowed elsewhere.

            Moreover, the bond prices also changes depending on the prevailing economic forces affecting the prices of the bonds (Megginson, Smart, & Lucey, 2008). In relation to this when the market rates increases the various bond usually demand a higher earnings from the bonds. This is to help the investors to cope up with high levels of inflation in such situations. On the other hand when the market rates decreases in times of deflation the bond rates usually goes down. This usually happens when there is a slowdown in the economic activities.  It has also been established that the prices of the bonds are less volatile when the bonds are near maturity. This therefore implies as the bond nears maturity the interest rates of the impact of the various interest of the bond become less. In addition, the final price of the bond depend on the credit quality and the type of the bond issued (Brigham, & Ehrhardt, 2011).  Most importantly the prices of the bonds also depend on the frequency of the payment of the bonds

 

 

  

 

References

Besley, S., & Brigham, E. F. (2008). Principles of finance. Mason, Ohio: South-Western.

Brigham, E. F., & Ehrhardt, M. C. (2011). Financial management: Theory and practice. Mason, OH: South-Western Cengage Learning.

Brigham, E. F., & Houston, J. F. (2009). Fundamentals of financial management. Mason, OH:South-Western Cengage Learning.

Megginson, W. L., Smart, S. B., & Lucey, B. M. (2008). Introduction to Corporate finance. London: Cengage Learning EMEA.