Corporate Bonds: factors that determine its interest rate

Question 1

What role does a company’s credit rating play in determining its bond interest rate?

Answer 1

Companies with lower credit ratings (higher default risk) must offer higher interest rates to attract investors. This compensation offsets the potential risk of the company not repaying its debt.

Question 2

How does inflation impact interest rates on corporate bonds?

Answer 2

If expected inflation exceeds the corporate bond’s interest rate, investors lose purchasing power. Bonds must offer an interest rate at least equal to or exceeding expected inflation to remain attractive investments.

Question 3

Why do bank deposit interest rates affect corporate bonds?

Answer 3

Corporate bond interest rates must compete with those of bank deposits (savings accounts, fixed deposits). If bank rates are higher, corporate bonds need to increase their offered interest rates to attract investors.

Question 4

Explain the relationship between yields on government securities (G-Secs) and corporate bond interest rates.

Answer 4

G-Secs act as a benchmark since they are considered very safe. When G-Sec yields rise, corporate bonds must offer even higher interest rates to remain attractive. This is because investors see G-Secs as a less risky alternative.