Business Finance Homework Help

Please respond to each student 100-150 words. Then respond to teacher

Initial Post

1. What is a bond? How is the price of a bond determined? How do interest rates impact a bond’s price? Explain.
2. Identify and discuss the most significant risks of bond investing.

Student 1

What is a bond? How is the price of a bond determined? How do interest rates impact a bond’s price? Explain. Identify and discuss the most significant risks of bond investing.

A bond is a unit of debt security (fixed income security) used issued by companies and governments in order to raise capital. Those institutions will issue bonds to borrow funds from investors for specific duration. The profit that investors make from lending their money is from the interest rates that were agreed upon. The price of a bond is set “by discounting the expected cash flow to the present using discount rate.” (Ross, 2021) Interest rates impact a bond’s price as the two are inversely correlated. When interest rates go up, bond prices go down and when bond prices go up, interest rates go down.

Significant bond investing risks are:

• Inflation risk which is the risk of the bonds value being eroded by inflation.
• Interest rate risk is when interest rate goes up as new bonds are issued and lower yielding bonds get less demand and when bond price goes up, payouts of old bonds get higher which makes them more attractive.
• Call risk is when bond issuers use their right to call their bonds before maturity, so they are only required to pay bondholders par value.
• Credit risk is when the bond issuer is unable to make payments on time.
• Liquidity risk which is because bonds are not liquid enough compared to stocks.
• Market risk is because bonds follow the laws of the market just as most other investments.

Inflation risk: Since bond interest payments are fixed. (n.d.). Bond investing risks. CNNMoney. Retrieved November 19, 2021, from https://money.cnn.com/pf/money-essentials-bonds-risks/index.htmlLinks to an external site..

Ross, S. (2021, September 13). How bonds prices are determined. Investopedia. Retrieved November 19, 2021, from https://www.investopedia.com/ask/answers/112614/what-determines-price-bond-open-market.aspLinks to an external site..

Student 2

A bond is the security that is issued in connection with a borrowing arrangement. Borrowers sell bonds to someone for an amount of cash. Issuers of bonds will make an agreement with the borrowers on some sort of payment arrangement to agree to make payments on specific dates. Most of the time the payment is the interest on the bond. To put it in simpler terms, think of a treasury bond. Several people use to purchase treasury bonds and on the treasury bond it displays when the bond will mature which can take anywhere from 20-30 years. Each year the bond is growing interest and once the bond is matured you can cash the bond in and collect the face value plus the interest the bond made over time, but you can cash the bond in at any time you just wouldn’t have as much interest paid out to you. The price of a bond is determined by the changes of the interest rates in the economy which could cause the bond prices to rise or fall at any given time. One risk is interest rate risk because the interest rate depends on the economy and could rise or fall. Reinvestment risk is another risk for bond investing because if you purchase a bond and it is getting 10%, once it matures and you reinvest the money to another bond the rate could fall to 2%. Lastly, default risk also is a risk because the bond issuer could be unable to pay the interest earned or the principal of the bond in a timely manner.

References

What Are the Risks of Investing in a Bond? (2021, April 12). Investopedia. https://www.investopedia.com/ask/answers/05/bondrisks.aspLinks to an external site.

Bodie, Z., Kane, A., & Marcus, A. (2021). Essentials of Investments (12th ed.). McGraw-Hill Education.

What Is a Bond? (2021, October 28). Investopedia. https://www.investopedia.com/terms/b/bond.asp#pricing-bondsLinks to an external site.

Teacher

Student initial post

1 Bond is a formal unconditional promise to pay a specified sum of money at a determinable future date, and to make periodic payments at a stated rate until the principal sum is paid.

Bond’s price is determined by getting the sum of the present value of the principal plus the present value of future interest payments using the effective rate.

Changes in interest rates have impact on bonds. By concepts of accounting, if the effective rate (market interest rate) is higher than the stated rate (coupon rate), then there is a discount which means that the bond’s sold is lower than the face amount. If the effective rate is lower than the stated rate, then there is a premium which means that bond’s sold is higher than the face amount.

2 Interest rate risk and Bond Prices.

Reinvestment risk and Callable Bonds.

Inflation risk and Bond Duration

Credit/Default Risk of Bonds.

Rating Downgrades of Bonds.

Liquidity risk of Bonds.

Listed above are the risk in bond investments. But the most significant risk among the six is the interest rate risk. In calculating the interest rate, it is the sum of real risk-free rate plus inflation premium plus market risk premium plus liquidity premium plus default premium. In every changes of its addends, the interest rates will also change. If interest rates will change, the price of the bond will change also.

Changes in interest rate is also affected by the supply and demand that is connected with inflation.

This is what the teacher is asking.

how much influence does the Fed have regarding the rates and the bond performance? Too much or too little?