Question

Explain why, when a company is making an investment decision such as buying corporate bonds, it cannot simply compare the size of promised payments from different investments, even if the interest rates and other risk factors are the same.

Answer 1

When the company is making investment decisions when buying corporate bonds, it cannot compare the size of promise payment from other investment even if interest rates and other factors are saved because bonds will be having different ratings associated with them and these bonds are also categorised as subordinated or senior bonds respectively so there will be assignments of preferences of payments and ratings to the bonds, and even if the interest rate and risk factors are the same, the recovery will not be similar for every bonds, and hence there need to be a specific assessment of investment decision when buying the corporate bonds.

Different corporate bonds have different durations and they are reacting differently to the changes in the interest rates and other macroeconomic factors because they have different priority of payments and and their credit ratings are also assigned differently and hence we cannot use similar parameter for comparison of these bonds with the other bones and we cannot use similar rate of interest and discount rate because they can lead to to false analysis and wrong investment so we need to assign a specific analysis and we will be incorporating a specific factors like sensitivity analysis and scenarios analysis along with other a specific factors which should be incorporated in the overall risk of these bonds and hence it can be said that we need to to examine the bonds from its own perspective and independently so that we will be having a lower chances of faultering on such investments.