Question

1.What is the relationship between interest rate level and bond price? Why must this relationship be true? How has the current rate environment impacted the prices of bonds?

2. What are some factors to consider in evaluating a company's ability to make payments on outstanding debt? Please explain the factors rather than just providing a list.

Answer 1

Answer to Question No 1

There is a inverse relationship between interest rate level and bond price,meaning thereby, when the interest rate increases the bond price goes down .Similarly,when the interest rate decreases the bond price goes up.

This relationship is true because the bonds are sold at discount to its maturity value.For ex- when market interest rate falls the bonds interest rate becomes more attractive which takes up its price.

The Interest rates are in downfall mode in the Indian economy, so the prices of the bonds are in upward direction.

Answer to question 2.

Following are the factors to consider in evaluating a company's ability to make payment on outstanding debt:

1.liquidity position of the company: whether the company is holding any current investment (whose maturity/which can be liquidated before the due date of the repayment of the debt).

2.Generation of free cash flows:the extent to which the company is able to generate positive free cash flow (Operating cash flow-investment in fixed assets) also determines the company's ability to pay the debt.

3.Interest coverage ratio:It is calculated as number of times the company's EBIT (Earning before Interest) is to interest expenses of that period .The higher ratio indicates the high ability to pay the interest on outstanding debt on time.