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Finance & Accounting
Pages 3 (753 words)
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.
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). ...
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