Question

WILL RATE HIGHLY!!! Please answer both questions with as much background as possible, thanks in advance!

1. Why Corporate Bonds are carrying "exchange prices" fluctuating everyday and different from it's original "Issued Prices" by corporations?

2. Describe how the market interest rate, relative to the contractual interest rate, affects the selling price of bonds. Also explain the rationale for requiring an investor to pay accrued interest when a bond is purchased between interest payment dates.

Answer 1

1) The prices of corporate bonds are calculated as present value of future bond cash flows for the investor discounted at the market rate of interest.

Since, the market rate of interest keeps fluctuating, the present value factor for discounting the bond cash flows changes and hence, resulting in exchange price fluctuations.

The market interest rate changes to several factors such as-

• Federal Bank policy changes
• Inflation rates
• Foreign currency reserves and many more.....

Note- In case of fluctuating bonds, the price of the bond is traded at par value at every reset date.

2) When the market interest rate is more than the contractual rate,
that means, investor will earn more if he invests in market securities than the bond since the market rate is higher. So, The bond is traded at discount in order to set off the future loss due to investment in bonds.

When the market interest rate is lower than the contractual rate,
that means, investor will more in bond than the market securites. This will encourage more investment for the bond. Hence, the bond is traded at premium.

Payment of accrued interest
When investor transfers his bond investments between the two interest dates, the interest accruing from the last interest date till the date of transfer actually belongs to the investor.
At the interest payment date the company issuing bonds will pay interest to the holder of the bond.
Hence, the purchaser pays the accrued interest portion to the previous investor which he will later receive from the company.