Question

1. Discuss why companies decide to issue bonds as a source of finance. (1 mark)
2. Explain why bond prices have an inverse relationship with interest rate movements. ( 1 mark)

Albert Page purchased one of Extra-large Shirt Company’s bonds last year when the market interest rate on similar-risk bonds was 6 percent.   When he purchased the bond, it had seven years remaining until maturity. The bond’s coupon rate of interest (paid semi-annually) is 5 percent and its maturity value is $1000. Today, the market rate on similar risk bonds as the one Albert purchased one year ago is 4 percent.

3. If he were to sell the bond today, what price he can sell it for?

Answer 1

COMPANIES DECIDE TO ISSUE BONDS BECAUSE

1) IF THE PROFITABILTY OF COMAPANY IS HIGH THEY GET BONDS ON FIXED RATE INTEREST HENCE SHAREHOLDERS EARNING PER SHARE INCREASES.

2) BOND WILL NOT DILLUTE THE VALUE OF EXISTING SHAREHOLDER.

3) MORE CASH CAN BE RETAINED FOR FUTURE

WHY BOND PRICE HAS INVERSE RELATIONSHIP WITH INTEREST RATE MOVEMENTS

ANSWER. BECAUSE IF MARKET INTEREST RATE IS LOW THAN BOND INVESTORS WILL ATTRACTED TOWARDS BOND AS IT GIVES HIGHER RATE HENCE BOND PRICE INCREASES.

IN OPPOSITE CONDITION IF MARKET RATES INCREASE AND BOND HAS LOW RATE , NOW BOND DEMAND WILL FALL AND PRICE OF BOND WILL DECREASE.

ANSWER 3

MARKET PRICE OF BOND=

USING ABOVE FORMULA

BOND PRICE COMES = $1052.88