Question

Answer the following questions on bonds:

1) What is the difference between interest rate and return on bonds, moreover, should the investors be more concerned about 'interest rate' or 'rate of return'?

2) The return on a bond is necessarily equal or not equal to the interest rate on that bond. Comment on it.

- Please write an elaborative answer (200-300 words), avoid short answer. Thank you - I will give you a like on your effort :)

Answer 1

Interest rate is also known as coupan rate on a bond

It refers to a fixed periodic payment to the bond holder.

It usually calculated on face value

for expample Bond A having Face Value $100 and interest rate is 10 % annually for 10 years and redemable at 100 .

It means bond holder will recive an annual amount of $10 (10% of 100) for next 10 years.

Hence it is the reward for holding bond

It does not very with the price investor pays for the bond .

hence here we are saying bond Market price is fluctuating

But we should here think why bond market price is flluctuate,

This is becouse market return expectation is changing with the time for a bond.

So in the given example if bond is paying interest rate of $10 and investor is ready to pay price of 110 then interest rate will be same however rate of return will be  9.09% .

in the above expmple we have not considered the capital appriciation however this will also be considered in rate of return however it will not be considered in Interest rate.

Hence it is clear that every bond is intrest rate is notional however rate of return is the mesure of the acctual return and it also discounts the capital appriciation hence rate of return is more accturate tool for deision making .

Hence investor should be more conserned about the Rate Of Return.

2.

Interest rate and Rate of return can be same also and it may be different also.

If the Market price of the bond is same as the face value and bond is reedmable at par then interest rate and rate of return can be same;;

However if the market price is more then the face value then interest rate and rate of return will be different as interst rate if fixed and price paid is more hence rate of return will be less then Interest rate in case of market price goes up.

so we can say that if maket price of a bond goes up then rate of return goes down and it has a inverse relationship.

In the same way if market price is less then the face value of bond is sold at a discount then return on the bond is higher then the Interest rate .

hence here also it has a inverse relationship if the bond market price goes down then rafe of return goes up.

however In both the condiation where market price goes up or down interest rate remain same and unchanged.

hence with the fluctuation in market price bond rate of return fluctuate but intrest rate will not.

Hence bond rate of return and interest rate may differ while face value and market rate differ and there is no provision for capital gain however if capital gain at the time of redumption is involved then dispite having same face value and market price bond interest rate and rate of return may be different.