B. VALUATION OF SHARES (10 MARKS) a. How does a bond issuer decide on the approp
ID: 2764789 • Letter: B
Question
B. VALUATION OF SHARES (10 MARKS)
a. How does a bond issuer decide on the appropriate coupon rate to set on its bonds? Explain the difference between the coupon rate and the required return on a bond.
- Please give a 300 words explain
(5 Marks)
b. Companies pay rating agencies such as the Standard and Poor Rating Service, to rate their bonds, and the costs can be substantial. However, companies are not required to have their bonds rated in the first place; doing so is strictly voluntary. Why do you think they do it?
- Please give a 300 words explain
(5 Marks)
Explanation / Answer
a) Bond issuers look at outstanding bonds of similar maturity and risk. The yields on such bonds are used to establish the coupon rate necessary for a particular issue to initially sell for par value. Bond issuers also simply ask potential purchasers what coupon rate would be necessary to attract them.
The coupon rate is fixed and simply determines what the bond’s coupon payments will be. The required return is what investors actually demand on the issue, and it will fluctuate through time. The coupon rate and required return are equal only if the bond sells for exactly par.
If the coupon rate is higher than the required return on a bond, the bond will sell at a premium, since it provides periodic income in the form of coupon payments in excess of that required by investors on other similar bonds. If the coupon rate is lower than the required return on a bond, the bond will sell at a discount, since it provides insufficient coupon payments compared to that required by investors on other similar bonds.
B)
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