Question

Week 5 DQ #1 CORP FIN (Interest Rates and Bond Valuation)

Please put together a memo to your Board of Directors, as the Company's CFO, which describes some of the risks associated with your Board's plans to raise capital by issuing bonds to the public. Please be sure to include the effects of inflation as well as provide the definition and some examples of liquidity risk, default risk, and tax-related risk, along with any other issues that you believe the Board should consider.

NO SCREEN SHOTS OR IMAGES OF RESPONSE. PLEASE TYPE YOUR ANSWER OR UPLOAD DOCUMENT IF REQUIREMENTS MENTIONED ABOVE ARE NOT MET I WILL GIVE A NEGATIVE RATING

Answer 1

There are many ways by which a company can raise capital. Some of them are through debt, equity, preference shares or retained earnings. The question above mentions that they wish to raise money through bonds i.e. debt. The idea is to issue bonds of the company to the public and then give interest to the bond holders from time to time. The bond prices are influenced by interest rates and inflation rates. As thr inflation rate increases, the bond price falls. There are also certain risks involved in the raising of capital through debt like liquidity risk, default risk and tax related risk. Liquidity risk is the situation when the company may have lack of funds and is unable to pay the interest to the bond holders on time. This is a huge risk for the company issuing the bond. The lack of funds may lead to the company not being able to pay the interest on time hence leading to default. This is known as default risk. The interest payments to bondholders are given tax exemption. This is the advantage of issuing bonds. Thus the company should issue bonds if it feels that it can make interest payments on time.