Finance Week 3

1. With an amortized loan, how does the relative distribution of a payment between principal and interest change over the life of the loan?

As payments are made on the loan, the interest amount will go down after each payment. This is due to the loan amount decreasing as a portion of the payment is applied to the principal. As the principal amount decreases over the life of the loan, so does the interest amount.  

1. Why is a call provision advantageous to a bond issuer?

If interest rates go up, the bond issuer will not raise the rates for the investor and the investor is stuck with the original coupon rate. If the interest rates fall, the bond issuer will call the bond and pay off the investor. In return the investor will have to reinvest their money at the lower interest rate. This covers the bond issuer as they reap the benefit once the interest rates rise or they can call the bond and pay off the investor if the interest rates drop.

1. What is the relationship between market interest rate movements and the value, or price, of a bond?

Although the in coupon rate will remain fixed, the market interest rate moves up and down and will impact the value of the bond. If the market interest rate increases will cause the outstanding bond to fall, whereas a decrease in the market interest rate will cause the bond’s price to rise.

1. What are bond credit ratings and how do they impact the bond’s return?

A bond credit rating is a grade level that is assigned to a bond that will distinguish their quality of credit. These ratings help determine the financial position of the issuing firm. The credit ratings can impact a bond’s return by not being able to sell the bond. If a bond credit rating is below a certain score, some purchasers will not be allowed to buy them. Also, a bond’s rating will indicate their risk, which will influence the bond’s yield.