INTRODUCTION AND BACK ROUND STUDY

A bond is a fixed interest financial asset issued by governments, companies, banks, public

utilities and other large entities. Bonds pay the bearer a fixed amount a specified end date.

In finance, a bond is an instrument of indebtedness of the bond issuer to the holders. It is a debt

security, under which the issuer owes the holders a debt and, depending on the terms of the bond,

is obliged to pay them interest (the coupon) and/or to repay the principal at a later date, termed

the maturity date. Interest is usually payable at fixed intervals (semiannual, annual, and

sometimes monthly). Very often the bond is negotiable, i.e. the ownership of the instrument can

be transferred in the secondary market. This means that once the transfer agents at the bank

medallion stamp the bond, it is highly liquid on the second market.

Every bond is rated by at least one bond rating company. A bond rating gives investors important

information about a bond and its issuer and allows investors to make an informed decision when

deciding whether or not to buy a bond. Bond ratings have become essential tools that investors

rely upon when analyzing bonds

When a corporation issues a bond, credit rating agencies rate it as to the safety of principal and

interest based on the company's ability to pay. Credit ratings are important to investors because

the higher the rating, the safer the bond (Anon., 2014). But credit ratings are also important to

the issuers because they may affect the cost of doing business, access to capital and executive

compensation.

To sum up, a debt investment in which an investor loans money to an entity (corporate or

governmental) that borrows the funds for a defined period of time at a fixed interest rate. Bonds

are used by companies, municipalities, states and U.S. and foreign governments to finance a

variety of projects and activities.

Interest Expense

o The higher the credit rating, the less interest a corporation has to pay on its bonds

because investors are willing to accept slightly lower interest for more safety.

Bond interest remains fixed for the life of the bond. If the financial conditions of

the company later deteriorate and credit rating agencies lower their ratings on the

bond, the change may negatively impact its price in the secondary market but the

interest payments won't change. However, if the corporation is looking to issue

more bonds, those will get the lower rating and will have to be issued with higher

interest.

Marketability

o The higher a bond's rating, the more demand there is for a bond and the easier it is

for a corporation to sell it. Corporations with the highest credit ratings can also

raise more money that way.

Refinancing and Other Problems

o Many corporations use debt as a permanent source of capitalization, meaning that

when a bond issue matures, they refinance it with another one right away in order

to keep the funds. If the credit rating has been lowered, a corporation may not be

able to refinance at all, which may jeopardize ongoing operations. Some

corporations also borrow from banks. Bank debt may have several provisions

attached, including a requirement to maintain the credit rating above a certain

level. If the credit rating drops below that level, it may trigger all sorts of clauses

in the company's bank debt. These could include cancellation of a revolving credit

facility or a demand for immediate repayment of all outstanding balances.

Stock Investor Concerns

o Credit rating reflects the general financial condition of a corporation. When a

credit rating is lowered, it tells the stock investors that a company's financial

condition is deteriorating. Some may sell the stock as a precaution, or at least

abstain from buying more. The selling pressure and/or reduced demand may

depress the stock price and make it more difficult for a corporation to sell more

stock to raise capital.

Executive Compensation

o Company executives may own substantial amounts of stock and/or hold a lot of

stock options. A lower stock price means a drop in the executives' personal net

worth and inability to exercise stocks options.

Works Cited Anon., 2014. ehow.com. [Online] Available at: http://www.ehow.com/about_7279103_bond-ratings-

important-companies_.html [Accessed 30 march 2014].