Question

In: Accounting

Please give me the answer within 1hour 1.Mr. Hanson is a small business man. He has...

Please give me the answer within 1hour

1.Mr. Hanson is a small business man. He has two twin 7 years old daughters. Mr. Hanson is thinking about admitting them in a local school. Because his business is not going well due to lock down situation, he can’t earn well for meeting up the expenditures for his daughters’ schooling. Mrs. Hanson, wife of Mr. Hanson, has inherited Tk. 10,00,000 from her father which she is thinking to invest in such a way so that she can get a fixed amount of money every month from where she can easily spent for her daughters’ schooling. As a financial adviser, suggest her which credit market instrument is appropriate for her and why?

2. Callable bonds have a call premium. Why??explain with examples.

Expert Solution

1. Credit market often referred as Debt market is a market through which companies and government isuue debt to prospective investors and in return pay incomes majorly in the form of interest income.

In the given case Mrs Hanson is thinking of investing Tk. 10,00,000 which is inherited from her father to meet the expenditure for her daughters schooling. As she wishes to earn fixed income from the investment the most suitable credit market investment will be Investing in bonds.

The advantages of investment in bond are as follows:

a) The bonds pays a regular interest to the holder of the bond which is the need of the investor (Mrs.Hanson) in this case.

b) On maturity bonds give a redemption value. ie, capital appreciation for the investment.

c) Also there is certainity about the receipt of interest compared to other credit market instruments.

2. Callable Bond :- In this type of bond, the issuing company has the right to redeem the bond at any point of time before maturity. To compensate inveestors for this uncertainity, an issuer will pay a higher rate of interest than a non callable bond.

Let us understand the necessity of Callable bond.

Suppose A ltd has issued bonds with coupon rate 12% p.a for 15 years.

After 6 years market rate of interest has come down to 8%.

It means A ltd can issue a bond now with a coupon rate of 8%.

But A ltd is paying interest at 12%. That is facing additional cost of capital.

To avoid such an unfavourable situation, Callable bonds are issued because the company can redeem the high coupon rate bond aand issue new bond with lower coupon rate.

While doing the redemption of the bond, company may pay a call premium to compensate the loss of interest for the remaining life of the bond.

ekkarill92 answered 2 years ago

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