How does a company determine what interest to charge on a bond? At what point in...

How does a company determine what interest to charge on a bond? At what point in the process would a bond be sold at premium or discount? What are the stages of a bond?

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Expert Solution

The company detemines the interest rate to be charged on a bond is by the factors:

Federal funds rate - It is the interest rate that banks with excess reserve at the federal reserve district bank charge on other banks.
Fed's discount rate - the rate at which member banks borrow short term funds from Federal reserve bank. Fed directly control this rate.

A bond when traded above its par value is called as a premium bond or bond sold at premium. The trading is done at premium when it offers coupon rate higher than the existing rate of interest. This is done because investors wants higher yields and can pay more for it for the future benefit.

A bond which is traded less than its par value in the secondary market is called as a discount bond. The coupon rate will be lower than the interest rate. The investors as want a higher yeild, they will pay less for the coupoun rate lower than the prevailing rate.

There are 3 stages of bonds :

Investment goal - at this stage how much capital can be invested or maximizes is determined
Inveatment horizon - How long u need to access your money is the key point to determine
Risk tolerance - how much risk you can comfortably take is the key point.

ekkarill92 answered 1 year ago

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