Question

1) What is the advantage of issuing a bond versus issuing common stock?

2) What is the advantage of issuing a bond versus borrowing money from a bank?

3) How is the bond price determined?

Answer 1

1.

Advantage of issuing a bond versus issuing common stock :

Companies can raise money in two ways: by issuing shares of stock or bonds. Shares of stock are essentially portions of the company, with holders granted a right to the company's profits and, in some cases, to cast votes regarding the company's direction. Bonds, in contrast, are portions of loans which the company promises to pay back over time. While often advantageous, there are a number of disadvantages to issuing stocks and bonds.

In most countries, including the United States, companies that choose to issue stocks and bonds must abide by a number of regulations related to the disclosure of financial information. Companies that issue stock must send out quarterly reports disclosing their businesses' financial health, whereas organizations that issue bonds must offer a large amount of information related to the purpose of the bond as well as corporate assets. Stocks and bonds are both popular investment options, and most investors have at least some holdings in both securities. Investors buy both in an attempt to make a profit as stocks or bonds increase in value or age, while businesses create stocks and bonds to increase their capital, the funds they have available for investment. Despite these similarities, stocks and bonds have several key differences that make them highly differentiated security options.

2.

some advantages of issuing bonds versus borrowing money from a bank In Bank Loan end-use is specified. Bank Loan. Typically Bank Loan is tieup with certain project or purpose (eg. working capital). Bonds or Non-convertible Debentures (NCD) do not have to specify end-use Issuing bonds also gives companies significantly greater freedom to operate as they see fit - free from the restrictions that are often attached to bank loans Another advantage in Indian context is fixing of interest rate. In case of Bonds/NCDs interest rate is typically fixed at the time of the issue. The same is not true for Bank Loan Bond can be issued with various Options.Callable bonds are another option. They function like other bonds with the caveat that the issuer can choose to pay them off before the official maturity date. Convertible bonds are also a consideration Bank loans are pretty illiquid. Bonds or Debentures can be sold to others. If listed they can be sold or bought by anyone, providing exit option to investors.

3.

Bonds: A bond is a long term debt instrument. Bond issue divides a large liability into many smaller liabilities. Bonds issuing company is obliged to repay a stated amount at maturity and periodic interest at regular intervals.

Determination of the selling price of a bond : • The selling price of a particular bond is mainly dependent on the prevailing market rate or effective rate of interest on securities with similar risk and maturity. Hence the price of the bond is determined by the market forces. • Face amount of the bond is the stated amount payable by the issuing corporation at the maturity date otherwise called principal, maturity value or par value. • In return for the money borrowed companies agree to pay a stated rate of interest which is the effective rate of interest at periodic intervals called periodic interest. • Maturities of bonds range between 10 to 40 years. The price of the bonds is calculated as the present value of all the cash flows generated from bond investment at the market rate which is used as the discount rate in calculating the related present values. Selling bonds at premium: • If a bond issue worth $ 500,000 with 14% coupon rate and 10 years maturity period are sold at a premium that is more than the face amount when bonds with similar risk and maturity are yield 10% coupon rate in the market. • In order to equate the 14% coupon rate to 10% market rate the market forces price the bond issue at a premium. If bonds are sold at premium, bondholders pay higher amount than the face amount and thus it would be equal to the 10% market rate even if the bond yields 14% coupon rate. • If the present value of a bond is more than the face amount then the bonds are issued at a premium.

Selling bonds at discount: • If a bond issue worth $ 500,000 with 10% coupon rate and 10 years maturity period are sold at a discount that is less than the face amount when bonds with similar risk and maturity are yield 14% coupon rate in the market. • In order to equate the 10% coupon rate to 14% market rate the market forces price the bond issue at a discount. If bonds are sold at discount, bondholders pay lower amount than the face amount and thus it would be equal to the 14% market rate even if the bond yields 10% coupon rate. • If the present value of a bond is less than the face amount then the bonds are issued at a discount. Selling bonds at par value: • If a bond issue worth $ 500,000 with 10% coupon rate and 10 years maturity period are sold at their par value that is equal to the face amount when bonds with similar risk and maturity are yield 10% coupon rate in the market. • In order to equate the 10% coupon rate to 10% market rate the market forces price the bond issue at par value. If bonds are sold at par value, bondholders pay the stated or face amount and thus the 10% market rate would be equal to 10% coupon rate on the particular bond issue. • If the present value of a bond is equal to the face amount then the bonds are issued at par value.