Question

1- What is the difference between a bond’s coupon rate and its market interest rate (yield)?

2- How do credit (debit) ratings affect the cost of borrowing for a company?

3- Read the article entitled “The Lawsuits Keep Coming for J&J” and explain how the lawsuits can impact J&J’s financial statements.

Answer 1

1.) The bond coupon rate is the yield that is being paid off for fixed income security like bonds.

The market interest rate is the percentage charged by a lender from a borrower for the amount that has been lent or for the use of assets.

The difference between Coupon Rate and Interest Rate:-

• Coupon Rate is the yield of fixed income security whereas Interest rate is the rate charged for borrowing.

• Coupon Rate is calculated considering the face value of the investment whereas Interest rate is calculated considering the riskiness of the lending.

• Coupon rate is decided by the issuer of the securities whereas Interest rate is decided by the lender.

2.) The credit score for a company affects the availability of credit and creditworthiness. Also the cost of credit decreases.
A credit rating evaluates the creditworthiness (based on qualitative and quantitative information) of a debtor, especially a business (company) or a government.
It is an evaluation made by a credit rating agency or a lender, bank of the debtor's ability to pay back the debt and the likelihood of default.
A poor credit rating indicates that the company or government has a high risk of default, hence the lenders’ or bank becomes cautious and reluctant to provide any new financing to the company or government.
Also, the cost of financing for the borrower with a poor credit rating is high as compared to a borrower with a higher credit rating.

3.) Johnson & Johnson ( JNJ ) was recently asked by a jury in the state of California to pay $5.7 million in damages to settle a lawsuit pertaining to transvaginal meshes Less than a month ago, it was announced that Boston Scientific will pay $600 million to J&J to settle a lawsuit related to the acquisition of Guidant Corp. At the end of 2013, a court ruled that J&J will have to pay $2.5 billion in damages to settle hip implant lawsuits. While in some cases the company has won.

• Its financial statements suggest that the net outflow of cash pertaining to litigation expenses is significant. We usually don't price in the impact of future lawsuits while estimating future cash flows for a company, or in this case J&J, due to the unpredictable nature of court cases. However, if history were to repeat itself and the lawsuits continue, pricing their impact would imply chipping off 7% to 8% of J&J's value. Clearly, these lawsuits are expensive. However, it is believed that their incidence and net costs may go down going forward.