In: Finance
7.) An investor is looking through various bond alternatives for potential investment. She has noticed a large number of them are currently selling for less than their original par value and is confused and nervous as to what this may mean for her potential investment if she purchases one of these. Please describe how and why these type of situations occur.
The possible reason for a large of number of bonds currently selling for less than their par value can be that interest rates have moved up and probably bonds are having larger time to maturity and hence the interest rate effect might have pushed the bond prices lower due to the inverse relation between the bond price and yield.
Another can be due to economic downturn that most of the companies are forced to issue the bonds at discount and providing higher yields to the investors to compensate for the additional risk.
Now if the fall is due to general rise in interest rates and if she expects no further increase then it is better to purchase the bonds and locking a higher yield as no more price damage will occur and in fact she can benefit if interest rates move down which will increase bond prices.
But if the fall in prices is due to economic downturn then she should be careful as there will be possibilities of defaults coming in future which may put capital at risk.