Bond

From ArticleWorld


A bond or debenture is a long term debit instrument. Bonds issued by the government or the public sector companies are generally secured. The private sector companies issue secured or unsecured debentures. In the case of bonds or debentures, the rate of interest is fixed and known to the investors. A bond is redeemable after a specific period.

It is relatively easy to determine the present value of a bond since its cash flows and discount rate can be determined without much difficulty. If there is no risk of default; then there is no difficulty in estimating the cash flows associated with a bond. The expected cash flows consist of annual interest payments plus repayment of principal. The appropriates capitalization, or discount rate to be applied will depend upon risk ness of the bond.

The risk in holding government bond is less then the risk associated with a debenture issued by a company consequently a lower discount rate would be applied to the cash flows of the government bond and a higher rate to the cash flows of the company debenture.

Standard practice

A bond or debenture may be issued for a specified period of time. When a bond or a debenture has a finite maturity, to determine its present value, we shall consider annual interest payments plus its terminal or maturity value. Using the present value accept, the discounted value of there flows will be calculated. By companies the present value of a bond with its current market value, it can be determined whether the bond is over valued or undervalued.

Types

Bonds which will never mature are known as perpetual bonds. Perpetual bonds or debentures are rarely found in practice. The value of a bond depends upon the interest rate. As interest rate charges, the value of a bond also varies. There is an inverse relationship between the value of a bond and the interest rate. The value will decline when the interest rate rises and vice-versa.