Question

Explain Zero coupon bonds and adjustable rate bonds, do a comparison analysis for a client of which would be practical for a client that will be retiring soon, and there is an expected rate of inflation of 4% yearly, look at our current economic markets and recommend what strategy to use with these two tools.

Answer 1

Ans.

Zero coupon bonds:-

Zero coupon bonds is also termed as discount bond or deep discount bond which is been bought at a price lower than its face value which will be given back at the time of maturity. This type of bond doesn't make payments of interest in periods. It has already been paid when the bond reaches to the maturity level and its investors are in great advantage of receiving huge about of sum equal to the initial investment Example includes U.S. Treasury bills. It is used or both long term and short term investments.

A yield-to-maturity calculation is made by determining the interest rate (discount rate) that will make the sum of a bond's cash flows, plus accrued interest, equal to the current price of the bond. This calculation has two important assumptions: first, that the bond will be held until maturity, and second, that the bond's cash flows can be re-invested at the yield to maturity.

A spot rate calculation is made by determining the interest rate (discount rate) that makes the present value of a zero-coupon bond equal to its price. A series of spot rates must be calculated to price a coupon paying bond – each cash flow must be discounted using the appropriate spot rate, such that the sum of the present values of each cash flow equals the price.

Adjustable rate bonds:-

Adjustable rate bonds are given to the holders of other outstanding bonds that have been issued. The debt obligation is consolidated and transferred from current bonds to the adjustable rate bonds. Issuing adjustment bonds requires the permission of existing bondholders.

The terms of such a bond often include a provision that when a company generates positive earnings, it is required to pay interest and not required to so if earnings are negative. Depending upon the specific term of an adjustment bond, any missed interest payments may be fully accrued, partially accrued, or not accrued. In addition, because negative earnings do not create an obligation to pay interest, the company avoid the embarrassment of being deemed in default on its debt.These bonds are normally long term in nature. They are a long-term investment by the investors and on the other hand, they are long term sources of finance for the issuer

shift our retirement withdrawal rate to a level which does not touch principal, we suddenly start changing the way we view money. We save more because we’re not only thinking only about ourselves anymore. We invest more carefully because people are counting on us. We do our research more thoroughly because we want to help others.

Inflation is a perpetuity, so too can your retirement funds become through CDs, real estate, real estate crowd sourcing, P2P lending, dividends, and royalties. The more income streams you can produce the better. When it’s time to start sleeping in because you no longer have to work, you just might not need to withdrawal any of your retirement funds

The   comparison of these tools and forecasts that the exchange rate will change to offset price changes due to inflation based on this underlying principle. the “4% withdrawal rule” or any withdrawal rate that’s greater than a risk free rate of return for that matter. Times have changed. Interest rates are close to zero, the stock market isn’t a, and we are living much longer now.To use the above example, suppose that prices of pencils in the U.S. are expected to increase by 4% over the next year while prices in expected to rise by only 2%. The inflation differential between the two bonds are:

                                          4%-2%=2%

The relative economic strength approach looks at the strength of economic growth in different countries in order to forecast the direction of exchange rates. The rationale behind this approach is based on the idea that a strong economic environment and potentially high growth .