Question

1) What is an advantage of issuing a bond versus issuing common stock? 2) What is an advantage of issuing a bond versus borrowing money from a bank? 3) How is the bond price determined?

Answer 1

1) When a company needs to raise capital they have  two primary options. The first is to issue bonds and the next is to issue stock. These are two very different financial tools. Although stock can be preferable in some instances, bonds offer advantages that may make them the better choice for some companies. Publicly traded companies raise capital for their operations by issuing stocks and bonds to investors who supply the capital. By issuing bonds instead of stock, the company benefits from the use of investor funds without giving up ownership to the outsiders. Bond is a loan that investors make to a company. Stocks represent an ownership stake that an investor has. By raising money through bonds, a corporation can avoid issuing more shares, which dilute the ownership interest of existing stockholder.

Bonds can guarantee a steady stream of income to investors and repayment of the initial loan amount when the bond matures. Investors often prefer purchasing bonds rather than stocks from companies that have a long history of stable dividend payouts. Selling stock allows you to raise capital without the risk of bankruptcy. You can only go bankrupt on money you borrow from someone else, or as a result of a judgement against you. When you sell stock, you also may be able to take advantage of the buyer's expertise, contacts, labour or services.

2)Companies opt for bonds as it might be a cheaper form of finance. Banks cannot lend below their base rate. So good companies can get lower rates in the open market.
Banks are happy too with bank loans. With bank loans, they don't have to book mark-to-market losses or gains in their P&L statements.The interest rate companies pay bond investors is often less than the interest rate they would be required to pay to obtain a bank loan. Since the money paid out in interest detracts from corporate profits, and companies are in business to generate profits, minimizing the interest amount that must be paid to borrow money is an important consideration. It is one of the reasons healthy companies that don’t seem to need the money often issue bonds when interest rates are at extremely low levels. The ability to borrow large sums of money at low interest rates gives corporations the ability to invest in growth, infrastructure and other projects.

3) valuation of zero coupon bond = face value of bond / (1+r)t

valuation of redeemable bond= present value of coupon + present value of Redemption vale

= CF1 /(1+r)1 + CF2 (1+r)2 + CF3(1+r)3+.....................CFn/(1+r)n