Question

Bonds do not get the attention they deserve because they set the tone for interest rates and direction, which reminds one of the most important economic and financial variables. Discuss the importance of bonds and ONE of their advantages and ONE disadvantage to both the company and the investor. Also, are bonds a preferred method of raising capital for a company? Why or why not.

Answer 1

Bonds act as debt securities with the issuer owing a debt to bondholders, paying interest and the principal at maturity. They fluctuate in value with interest rates. Companies benefit from potentially lower interest rates for bonds versus other financing, while investors gain a predictable income, though both face risks of varying degrees.

Step-by-step explanation:

Bonds are debt securities under which the issuer owes the holders a debt and, according to the terms of the bond, is obligated to pay interest (the coupon) and repay the principal at a later date (maturity date). For example, if a bond with a par value of $1,000 is issued when interest rates are at 5%, offering an annual coupon of 5%, it will yield $50 annually to the bondholder. The market value of bonds fluctuates with changes in interest rates, impacting their attractiveness to investors.

From a company's perspective, one advantage of issuing bonds is that it can typically secure lower interest rates compared to other means of financing, like bank loans. Additionally, it provides the firm with financial flexibility and can be a less restrictive way of raising capital. However, one disadvantage is the legal obligation to make coupon payments and repay the principal, which can be a burden if the company's cash flow is inconsistent.

From an investor's perspective, the advantage of purchasing bonds is receiving a predictable income stream through coupon payments, which can be especially alluring during low-interest-rate environments. However, the disadvantage lies in the risk of the issuer defaulting on payments and the potential loss of value if interest rates rise after the bond has been purchased.

Bonds can sometimes be a preferred method of raising capital for a company, particularly for established companies with good credit ratings that can issue bonds at attractive rates. However, for smaller companies or those with weaker credit, the cost of borrowing may be too high, and other financing options, like equity or bank loans, might be more viable.