Managerial Finance Final Exam
Final Examination Paper
BUSI570 Managerial Finance
Prepared by: nansla
Columbia College
3 December 2012
Topic 2:
What affect does inflation have on bond prices or interest rates for new or existing bonds?
The price of bonds on the market can be either higher or lower than the face value of the bond depending on the current economic condition or the market condition, which can affect the price investors are willing to pay (Fidelity Investments, 2012). In regard to price, the bond prices are provided in terms of a percentage of par value. The price investors are willing to pay can be greatly affected by the current interest rates. For example, if interest rates inflate after the bonds are issued, the prices on the existing bonds will usually fall (Fidelity Investments, 2012). This happens because new bonds are often issued with higher coupon rates as interest rates increase, which makes the older outstanding bonds less attractive unless they can be purchased at a lower price resulting in lower prices for existing bonds (Fidelity Investments, 2012). The inverse is true when interest rates decline, which means investors can sometimes sell a bond for greater than the purchase price when interest rates go down since other investors are willing to pay a premium for a bond with a higher interest payment or coupon rate (Fidelity Investments, 2012). Inflation also leads to a higher interest rates, therefore inflation has the same effect as interest rates: when inflation rises, the price of a bond tends to drop (Fidelity Investments, 2012). A fixed-rate bond’s coupon rate normally remains unchanged for the life of the bond, so the bond may not be paying enough interest to stay ahead of inflation (Fidelity Investments, 2012). The longer a bond’s maturity, the greater the odds of inflation eventually lowering the bond price. For this reason, long term bonds often attract buyers by using higher interest rates to combat the fear of a rising inflation rate
BUSI570 Managerial Finance
Prepared by: nansla
Columbia College
3 December 2012
Topic 2:
What affect does inflation have on bond prices or interest rates for new or existing bonds?
The price of bonds on the market can be either higher or lower than the face value of the bond depending on the current economic condition or the market condition, which can affect the price investors are willing to pay (Fidelity Investments, 2012). In regard to price, the bond prices are provided in terms of a percentage of par value. The price investors are willing to pay can be greatly affected by the current interest rates. For example, if interest rates inflate after the bonds are issued, the prices on the existing bonds will usually fall (Fidelity Investments, 2012). This happens because new bonds are often issued with higher coupon rates as interest rates increase, which makes the older outstanding bonds less attractive unless they can be purchased at a lower price resulting in lower prices for existing bonds (Fidelity Investments, 2012). The inverse is true when interest rates decline, which means investors can sometimes sell a bond for greater than the purchase price when interest rates go down since other investors are willing to pay a premium for a bond with a higher interest payment or coupon rate (Fidelity Investments, 2012). Inflation also leads to a higher interest rates, therefore inflation has the same effect as interest rates: when inflation rises, the price of a bond tends to drop (Fidelity Investments, 2012). A fixed-rate bond’s coupon rate normally remains unchanged for the life of the bond, so the bond may not be paying enough interest to stay ahead of inflation (Fidelity Investments, 2012). The longer a bond’s maturity, the greater the odds of inflation eventually lowering the bond price. For this reason, long term bonds often attract buyers by using higher interest rates to combat the fear of a rising inflation rate
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