Many of you have heard about buying into the stock market, where you have heard

Question

Many of you have heard about buying into the stock market, where you have heard to buy when a stock is low, and sell when it is high. However, business is not always quite that simple. The reason is that economic conditions tend to create these highs and lows, and these same economic conditions also tend to provide, or remove, a stable environment in which a business can profit in a healthy manner. Imagine, if you can, a scenario in which the economy is starting to begin a descent into a recession. Many economists will tell you that we do not know we are in a recession until we have already been in it for some time since the data that is required to make that determination takes some time to accumulate.

With that being the case, do you think it may be possible for a business to offer bonds to the bond market when there is a recession around the corner? Why do businesses offer bonds instead of using retained earnings in the first place? If you are an investor who is considering using ROIC to invest in the bond, how useful would it be under these conditions?

Explanation / Answer

Bond markets are relatively safer compared to other market instruments. Reason being bonds are debt instruments and carry a fixed rate of interest. Hence, payments against bond are relatively safer.

If there is condition of recession, it is based on the judgment of the investor. Although, once a company issues a bond, it is liable to pay the interest irrespective of its financial condition as it is a debt instrument. However, cautious investor may or may not invest considering the economic climate.

Retained earnings basically is the amount of capital saved from the profit. Hence, it is generally used to meet unforeseen circumstances where the requirement of amount is immediate. Apart from that, it is also used for further investment. Hence, the company may not be desirous of financing its requirement out of its reserves. Rather, it may be inclined to use external sources of funds to finance its projects and other short term needs especially in times of recession.

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