B. VALUATION OF SHARES (10 MARKS) a. How does a bond issuer decide on the approp

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. (5 marks)

Please give a 200-300 word explanation

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? (5 marks)

Please give a 200-300 word explanation

No plagiarism and please include any references if you used them

Explanation / Answer

a) Bond issuers look at outstanding bonds in the market that are 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 bond issuers also take the help of underwriters to decide the coupon rate on the bond, certain factors such as the length of maturity and the rating are also considered for determining the rate on the bond.

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.

b) The companies prefer to get their bonds rated by the rating agencies so that the investor would know the level of risk associated with the bond investment. A good rating on the bond would increase the investors confidence to invest in the bond. It not only increases the investors confidence it also increases the regulator confidence in the bond.

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