There are two kinds of bonds including those issued by government and the bonds issued by corporations. Corporate bonds are considered one of the major forms of investment vehicles where people save their money in order to plan for their retirement. Corporations issue bond so that they can raise capital; the investor is paid an interest on the invested amount by the corporation (Asquith & Au et al., 2013). There are many factors that affect the interest rate of a bond: the first factor is the level of risk involved; investor lends the money to the corporation and receives interest based on the risk factor. The risk factor is assessed by rating the credit worthiness of the bond by the rating companies like Moody’s, Standard and Poor’s and Fitch (Baele & Inghelbrecht, 2010). If the rating is higher, the risk shall be lower and so the interest rate shall also be lower for the bond. The risk is higher when credit rating is low and so the investor gets compensated through a higher rate of interest.
Bonds are traded like stocks in the marketplace; it is affected by the supply and demand based upon the company’s credit quality. This in turn affects the purchase price of the bond leading to a change in the interest rate yield. If the selling price of the bond drops below the value, the return on interest shall be higher as the purchase has been on a discount. Another factor that affects the interest rate is the type of bond; companies issue convertible as well as non-convertible bonds. Lower interest rate is offered by the convertible bonds; these bonds can be converted into common stock making the investor an owner at some time rather than a lender (Baele & Inghelbrecht, 2010). In contrast, the non-convertible bonds offer a higher rate of interest.
One of the common factors influencing the financial markets is the future uncertainty; this means more risk. When there is higher uncertainty regarding the bonds, the price of the bond lowers while the yield is higher. Bonds having longer maturities carry more risk as there is more uncertainty in the long run as compared to the short run (Asquith & Au et al., 2013). The price of bonds keep on fluctuating; when the price falls, the interest rate rises as the investor gets the same rate of interest by paying less. But when the price increases, the yield decreases.
References
Asquith, P., Au, A. S., Convert, T. & Pathak, P. A. (2013). The market for borrowing corporate bonds. Journal Of Financial Economics, 107 (1), pp. 155-182.
Baele, L. & Inghelbrecht, K. (2010). The determinants of stock and bond return comovements. The Review Of Financial Studies, 23 (6), pp. 2374-2428.
