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Time Value of MOney - Research Paper Example

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Time Value of MOney

Before calculating the discount rate and valuing the security to its present value, the overall features of the debt security may help determine what should be the value of the bond, whether it should be below, above or at par (Seeking Alpha, 2012). The first important factor to be considered is the rating of the company. If it is an AAA or AA rated company, then it is very safe to assume that the company will pay all its debt obligations and it is alight to pay $ 1000000 now to get the same amount back later. However if a company has a lower rating then it would not be sensible to pay that much for the bond. Another important factor is what the prevailing interest rate for the bond is. If the interest rate for the bond is above the coupon rate that the bond makes payment upon, then the bond will be placed at a value that would be less than par. Alternatively, if the interest rate for the bond is below coupon then more should be paid, and if the interest rate is equal to par, then the same principal amount should be paid. Another important consideration is what the interest rate at issuance of bond is. If the interest rate is low, then the bond carries interest rate risk which means that if interest rate rises in future the value of the bond will fall. Alternatively, if the interest rate is high, the bond carries reinvestment risk (Yahoo, 2011a). The most important factor in the economy is the inflation rate. If the inflation rate is high then it does not make sense to pay the principal

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amount for this bond, because the value of the dollar will fall next year. Lastly, a personal factor for consideration is how risk-averse the investor is. Taking all factors into consideration, being an investor I would pay less than $ 1000000 for the bond to receive the principal i.e. $ 1000000, one year from now. 2) The ratio analysis is used to evaluate the discount rate for ENERSYS (Enersys, 2005). ENERSYS Beta is 1.63, which shows that returns are fairly volatile to the market. ENERSYS, Profit margin is 26% which means that it can pay off its bond obligations. Its other ratios also look healthy. ENERSYS Debt/Equity ratio is 26%, which means that it has a fair amount of equity in its capital structure and less debt, so it bears less risk of default. It has a ROE of 12%, which shows that it provides a good return on its equity. Looking at the above figures it is reasonable to assume that the discount rate would be 7-8% for ENERSYS. 3) The other company for which I would pay significantly less than $ 1000000 is Exide technologies. Exide has a beta of 2.34 (Yahoo, 2011b) which means that it has a high systematic risk and returns that are very volatile compared to the market. It has a debt/Equity ratio of 187% and a lesser profit margin of 1%, so it carries a huge amount of risk and its discount rate would be very high based upon these factors. It carries a lot of default risk with it. Maxwell Technologies has been chosen as a company that carries with it very less risk and for which more could be paid as it has a negligible default risk and its ratios are very healthy. 4) I have learnt what factors are necessary to determine the discount rate for a bond. Factors embedded in a bond such as its coupon rate, its interest rate, the level of default risk, inflation rate risk and other personal preferences of the individual themselves play a key role in determining the discount rate (Davis M, 2000). The most important

Summary

Time Value of Money The situation that a client of the company is facing is whether to buy a fixed income security i.e. bond, which will pay $ 1000000 a year from today. The detailed features of the bond, whether it is a coupon paying bond or a zero coupon bond is not known…
Author : andersonangela
Time Value of MOney essay example
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