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In: Accounting

Sally Smith works for Peterson Press, a fairly large book publishing firm. Her best friend and...

Sally Smith works for Peterson Press, a fairly large book publishing firm. Her best friend and rival, Molly Murray, works for Lifeline Books, a smaller publisher. Both companies issued $100,000 in bonds on July 1. Peterson's bonds were issued at a discount, while Lifeline's were issued at a premium. Molly sent Sally an email the next day. She told Sally that it was obvious who the better publisher was—the market had shown its preference! She reminded Sally again of her recent increase in salary as further proof of the superiority of Lifeline Books.

Instructions
Draft a short note for Sally to send to Molly. Explain how such a result could occur.

Solutions

Expert Solution

[Draft Note for Sally]

Dear Molly,

There are two factors related to a bond - one is pricing and the other is performance. Pricing is related to how a Bond is priced in the market and Performance relates to how it performs over a period interval of time vis-a-vis its benchmark and similar category bonds.

Pricing of a bond is related to the follwoing factors :

1. Market required rate of return of a particular featured bond.

2. Coupon Rate of the bond

3. Yield Curve of Interest Rates

4. Tenure of Bond Maturity

5. Type of Bond

6. Interest type, i.e. whether floating or fixed.

All the 6 factors have no connection with the actual coporate performance of the bond issuer. They are financial metrics which determine the pricing of bond, i.e. whether it is priced at a discount or at a premium. Bond priced at a discount simply means that the Coupon Rate of the bond is lower than coupon rates on similar bonds and if they are priced at a premium, implies Bond issuer is paying a higher coupon rate than the market.

Based on this, it might be pertinent to bring to your notice that out company pays a lower coupon than the market and subscribers buying our bonds on this condition , implies the faith they have on our company financials. On the other hand, your company has to pay a higher interest rate to subscribers to make your security attractive enough for investors, implying lower confidence on your company financials.

Please make informed decisions before shooting a mail, randomly.

Yours

Sally

ekkarill92 answered 2 years ago
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