Week 2 post 3 review minimum of 150 words apa format
1. How do bonds provide financing to corporations for their capital projects?
Companies sell bonds (i.e. borrow money) to investors so that they can raise capital to support day-to day-operations as well as finance long-term projects. A bond is a legal obligation from the company to the bondholder that the company will pay the bondholder the principal amount invested plus interest at a future date. Companies that are able to make the required interest payments on time as well as pay back the principal at the maturity date can receive high credit ratings from agencies such as Moody’s and Standard & Poor’s (S&P) and thus can attract potential investors in the future (Ross, Jordan, & Westerfield, 2016).
2. What are the key differences between using bonds to finance capital projects and using stock for that purpose?
When a company issues a bond to an investor, they are agreeing to pay interest semi-annually or annually on the value of the bond and to pay off the principal at maturity. The benefit for a company to finance their projects with bonds is that the interest paid out on the bonds is not taxed and therefore offers considerable savings (Flowers, 2016). Companies can also raise money quickly by selling stock to investors to finance projects. Unlike bonds, investors who buy stock own a piece of the company and are paid dividends based on the company’s performance throughout the year.
1. The value of a bond is dependent primarily on two factors. Name and explain these factors.
The value of a bond is dependent on the interest rate and the credit worthiness of the company that is issuing the bond (Summary of Bond Market video). When a company wants to issue bonds to investors, they need to set interest rates that are comparable with other companies so that they can attract investors. Also, smart investors will look to see if a company has ever defaulted on paying of their debt by looking at a company’s bond rating. Companies with lower ratings pose a higher risk to potential investors which can have a negative effect on future financing opportunities.
2. Compare and contrast the differences between stocks and bonds.
Selling stocks and bonds are two ways that a company can generate funds to finance their operations and future projects. When companies sell bonds, they are taking on long term debt with the promise of paying back the face value of the bond plus interest to investors. Stock, on the other hand, allows a company to raise money by selling ownership of the company to investors. The company is not taking on added debt by selling stock and therefore does not have to worry about paying back loans and interest (Ross, Jordan, & Westerfield, 2016).
Flowers, B. (2016) Financing Businesses and Public Projects with Stocks and Bonds.
Ross, S. A., Jordan, B. D., & Westerfield, R. (2016). Fundamentals of corporate finance. New York, NY: McGraw-Hill/Irwin.
Summary of the Bond Market video. Fundamentals of corporate finance. New York, NY: McGraw-Hill/Irwin.