Bonds as an Investment Option - Assignment Example

The paper “Bonds as an Investment Option" is an informative example of an essay on finance & accounting. The author explains why he would purchase a bond as an investor.
Bonds are long term debts sold by companies to investors.  The investor lends money to a company or government in exchange for a predetermined interest rate (Kennon, 2011). 

There are several reasons why one would purchase a bond.  First, bonds have competitive interest rates.  They earn more than ordinary savings or time deposit accounts.  Second, bonds have a guaranteed minimum return.  As a bond investor, one is shielded from interest rate fluctuations because it has a fixed interest rate regardless of inflation.  This means that it can provide a predictable income stream for the investor (The Securities Industry and Financial Markets Association, 2010).  The third reason why one would purchase bonds is that one does not have to invest a huge sum of money.  For as little as $50, one can already buy U.S. savings bonds.  Government bonds are also a safe investment because they are guaranteed by the U.S. government.  Furthermore, interests earned in U.S. savings bonds are exempt from all state and local income tax (12 good reasons for buying bonds, 1995).  Another reason that one would purchase a bond is due to the fact that investing in bonds is safe since one’s capital investment is preserved unlike in the stock market.  Bonds are a very good supplement for retirement income, for financing the education of one’s children or for buying a new home.

2. How important are bond ratings when evaluating a bond for purchase?
“Bond rating is a grade given to bonds that indicates their credit quality” (Investopedia ULC, 2011).  The ratings are given by private independent firms such as Standard & Poor’s, Moody’s and Fitch.  The bond ratings range from ‘AAA, being the highest grade to ‘C’ or “junk” being the lowest grade (Investopedia ULC, 2011). 

Before purchasing a bond, it is important to look at the bond rating to determine the quality of the bond.  The rating is a gauge of the financial strength of the company (Bouchentouf, Dolan, Duarte, & al, 2011).  If a company is given a high bond rating, then one can be assured that it can pay its obligations.  If the rating given to a firm is low, then one can say that the financial health of the company is questionable and that there is a high risk that the company may default on its obligations.  Bond ratings are essential because it helps investors to determine the relative risk involved in purchasing a certain bond.  Investors can better evaluate the financial performance of a company with the help of the bond rating.  Bond ratings give an overview of the credit quality of the issuer of the bond.

Bond ratings have a great impact on the borrowing power of a company.  If the rating given to a company is high, it is easier for them to borrow money at a lower cost.  However, if the rating is low, it is more difficult to attract investors to purchase the company’s bonds.  This would mean that they would have to offer higher interest rates to persuade investors to buy their bonds.  One can, therefore, say that bond ratings also have a significant effect on the profitability of the company since interest rates paid on the bonds affect the interest expense figure in the income statement (Money-Zine.com, 2011).