Question

An investment banker agrees to underwrite a $600 million, 10-year, 10 percent semiannual bond issue for ABC Corporation on a firm commitment basis. The investment banker pays ABC on Thursday and plans to begin a public sale on Friday. What type of interest rate movement does the investment bank fear while holding these securities? If interest rates rise five basis points, overnight, what will be the impact on the profits of the investment banker? What if the market interest rate falls five basis points?

Answer 1

Basically, Investment Bank is an intermediary between corporation and investor which engaged in buying securities from the corporation and issue to investors based on a contract or simply just facilitate the processing and earn profit as commission. In this case, Investment Banker is issuing 10 years,10% half-yearly Bond for ABC Corporation based on a commitment on Friday. In this scenario, the Interest rate movement is a major fear in the mind of an investment banker. What if the interest rate goes up? That is the main fear in the mind of Investment bankers because investors are less keen to invest in this Bond issuing for ABC Corporation by Investment Banker which will result in fewer subscriptions because other alternatives available in the market and Bond Price will go down.

If Interest rates rise five basis points, then it will have a very slight impact on the subscription of the issued bond and then investors will focus on other details like Bond Rating and Bond Price will go down on the next market day. If this change happened before the issue, then Investment Bankers must have to change the Issue Price of the bond before issuing in the market. Therefore, fewer subscriptions will lead to a negative impact on Profit. If Interest rates fall 5 basis point, then it will become one of the best alternative and Price will goes, resulting to significant increase in Profit.