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In: Finance

Regarding corporate bonds, how does a firm decide on the appropriate coupon rate for its bonds?  ...

Regarding corporate bonds, how does a firm decide on the appropriate coupon rate for its bonds?   How is the required rate of return different than the coupon rate?

Solutions

Expert Solution

Bonds issued by company are referred to as corporate bonds. Bonds are often categorised by their coupon rates : fixed - rate bonds, floating rate bonds and zero coupon bonds.

A fixed rate bond has a finite life that ends on the bonds maturity date, offers a coupon rate that changes over the life of the bond, and has a par value that does not change.

The coupon rate of a floating rate bond is usually linked to reference rate. The London Interbank Offered rate (LIBOR) is widely used reference rate.

Zero coupon bonds have a finite life that ends on bonds maturity date. Theydo not offer periodic interest payments during the life of the bond. Companies sometimes issue zero coupon bonds that have maturities longer than one year.

A bonds coupon rate is the actual amount of interest income earned on the bond each year based on its face value. A bonds Yield to maturity (YTM) is the estimated rate of return based on the assumption that it will be held until maturity and not be called. Atface value, coupon rate and yield equal each other.


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