Question

Please explain why bond prices are subject to changes in interest rates.

Describe the characteristics of a bond and provide an example of a firm or government entity that has recently issued (sold) these securities.

Need 300 words discussions

Answer 1

Answer:

          Bond prices have inverse relationship with the market interest rates. That means when the market interest rate increases, the bond prices falls and when the market interest rates decreases, the bond prices goes up.

          This is because at the time of issuing bonds, its coupon rate is fixed at higher rate than prevailing market interest rates. The purpose of fixing higher coupon rate than market interest rate is to compensate additional risk taken up by the investor while investing bonds.

          When the market interest rate increases, the expected return of bond investors also goes up thus making the bond investment less attractive.thus bond prices fall. Similarly, when the market interest decreases, the expected return also decreases making the bonds more attractive as it gives higher return to expected rate of return of investor. Thus bond prices goes up.

Characteristics of bonds:

1. Bonds are issued by govt organisations both state and central Govt. organisations, municipal corporations etc for their finance needs.
2. Bonds are issued with a long term life period normally more than five years.
3. Bond carries a fixed coupon rate to be paid annually.
4. The interest amount payable on the interest rate is tax deductible.
5. Bond holders don’t have any voting rights unlike any equity share holders.

Example:

          Jain Irrigation Systems has raised $200 million through issue of dollar bonds in February 2017. The bonds will mature in 2022 and carries an coupon rate of 7.125% per year.