Question

Time Value of Money, Bonds Risk and Valuation

a) Provide a detailed description of the topic.
(b) Provide two examples of how the selected concept is applied.
(c) Discuss the challenges faced with the concept selected. As part of this discussion, how will the selected item be implemented/Used in an organization and its significance?
(d) Discuss how the selected concept will change 5 years from now. What can the organizational leaders, financial analyst do today to ensure they are prepared for these advancements?
(e) Provide a graph chart or data with sample numbers indicating the topic you selected?

Answer 1

Time value of money:

The time value of money is the concept that says that the money which you own now is more valuable than the same amount of money in the future. For an eg value of 1 dollar, today is much higher than the value of a dollar tomorrow. The difference between the value we allot to inflation.

The selected concept can be applied in various ways:

Eg 1. In calculating the retirement savings time value of money concept is used. Let's say today my monthly expense is $5,000 dollars so what equivalent amount should I save per month till the time I retire so that my living standard is not compromised this thing can be answered by the time value of money.

Eg 2. For company time value of money can be used to find the present values of the future cash flows.

The challenges faced by this concept it if there is deflation, then the money owned now is less valuable then the money owned in the future this happens at the time of recession or depression where people don't want to invest anywhere and just want cash with them. when there is extreme fear sentiment. So the organizations cannot estimate with surety that what will be the exact time value of money. what measures to be taken in the case of deflation.

Bonds Risk and Valuation:

Bond is the debt instrument. Bonds signifies a promise to pay a certain amount at a certain point of time in the future while in the between period interest or the coupons are paid. Bonds do not provide ownership of the business bond issuer and have to pay back the bond amount to the subscribers. Bonds are issued by the countries as well as corporates. The riskiness of the bond depends upon who issued it and for what purpose it has been issued. Bond valuation is the factor of prevailing interest rates duration and the risk.

Eg.1 If an AAA-rated company issues a bond then the riskiness of the bond will be low and its coupon will also be low.

Eg.2 If the prevailing interest rate or yields falls in the market then the valuation of the bond will increase as the coupon of the bond will not change as a result the bond will give more return then the market, as a result, its valuation increases, for duration bonds the prices will increase more then the long-duration bonds.

The challenges faced in this concept is when there is economic uncertainty or a recession like the situation the yield of short term and the long term bonds may be inverted means short term yields can become more than the long term yields giving a lot of uncertainty in corporate, corporates won't be able to raise the money in the market for short term at low rates during such times.