Question

What is the relationship between interest rate level and bond price? Why must this relationship be true? How has the current rate environment impacted the prices of bonds? What are some factors to consider in evaluating a company's ability to make payments on outstanding debt? Please explain the factors rather than just providing a list.

Answer 1

Interest rates and bond prices tend to be inversely related. When rates rise, the bond prices fall. This is because due to increased rates, the future cash flows of the bonds are discounted more. A higher discounting leads to a less present value and hence less price of the bond.

The current rate environment is on rise with Fed increasing the rates over past year. This shall lead to lower prices of the bond.

The factors to consider in order to evaluate company's ability to pay debt are:

• The cash flows- Sufficient cash flows would enable easy payment
• Profitability- A higher profitable firm shall have a greater chance of paying off debt
• Current ratios- Whether the firm has enough liquidity to pay off the debt.
• Market Share and essential product- For example a company may have a product that is essential. It shall then have a greater chance of paying the debt.