Question

The investment should be made now because due to higher market interest rate, it would be available at discounted price with reduction of 2% it is expected that MV will be up. I think that the effect on ABC's financial statements would be that the Capitol Gains and profit in the financial statement would increase. Furthermore, one should hold the bonds until it gives a capital gain.

But what about the future value of the investment, Could that change an investors decision at all? If so how?

Answer 1

A bond is a loan that the bond purchaser, or bondholder, makes to the bond issuer. Governments, corporations and municipalities issue bonds when they need capital. An investor who buys a government bond is lending the government money. If an investor buys a corporate bond, the investor is lending the corporation money. Like a loan, a bond pays interest periodically and repays the principal at a stated time, known as maturity.

Every bond also carries some risk that the issuer will “default,” or fail to fully repay the loan. Independent credit rating services assess the default risk, or credit risk, of bond issuers and publish credit ratings that not only help investors evaluate risk, but also help determine the interest rates on individual bonds.

Put simply, when interest rates are rising, new bonds will pay investors higher interest rates than old ones, so old bonds tend to drop in price. Falling interest rates, however, mean that older bonds are paying higher interest rates than new bonds, and therefore, older bonds tend to sell at premiums in the market.

On a short-term basis, falling interest rates can boost the value of bonds in a portfolio and rising rates may hurt their value. However, over the long term, rising interest rates can actually increase a bond portfolio’s return as the money from maturing bonds is reinvested in bonds with higher yields. Conversely, in a falling interest rate environment, money from maturing bonds may need to be reinvested in new bonds that pay lower rates, potentially lowering longer-term returns.

Unlike equities, bonds should repay principal at a specified date, or maturity. This makes bonds appealing to investors who do not want to risk losing capital and to those who must meet a liability at a particular time in the future. Bonds have the added benefit of offering interest at a set rate that is often higher than short-term savings rates.