Question

Explain the following briefly with your own words. (max 200 words for each.)

Assume as if you are explaning the matter to one of your colleagues who did not take acc. & finance course.

• 3) What are the determinants(components) of interest rates for bond issues?
  

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Answer 1

A bond is the obligation of the company which is required to be mature after a certain period of time. A bondholder is one to which the company is liable to pay. The company pays the interest at a regular period and the principal amount at the time of maturity. The company pays interest for using the bondholder’s money.

The rate of interest is dependent upon the two components which are:

1. Credit rating, 2. Time value of money

Credit rating is the rating of the bond which shows the ability of the company to pay the interest as well as principal. If the credit ratings are low, the interest rate is high because the company attracts bondholders by paying a higher rate of interest. If the credit ratings are high, the interest rate is low.

Time value of money is the concept which explains that money worth also depends upon the passage of time. Similarly, the rate of interest on bonds are also dependent upon time. If the bonds are issued for a longer period of time, the rate of interest on such bonds is high and if the bonds are issued for a shorter period of time, then the rate of interest on such bonds is low.