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State the circumstances under which it would be advantageous to lenders and to borrowers from the issue of: (i) Debentures with a floating rate of interest. (ii)...

      

State the circumstances under which it would be advantageous to lenders and to
borrowers from the issue of:

(i) Debentures with a floating rate of interest.

(ii) Zero-coupon bonds.

  

Answers


Martin
i) Debenture with floating interest rate:
- A debenture whose interest rate is variable and pegged to charges in interest
rate on Treasury bill e.g. a debenture/bond may have a 3% premium above
interest rate on Treasury bill such that:-
If interest rate on treasury bill is 7%, interest rate on the bond is 7% + 3% = 10%
If interest rate on Treasury bill rises to 8.5%, the interest rate on the bond rises to
8.5% + 3% = 11.5%.
- Such a bond is advantageous when market interest rates are volatile.
- If market interest rate falls the borrower pays lower interest charges and when
it rises, the lender receives more interest income.
- Since the coupon rate is matched to market interest rate, the intrinsic value of
the bond is usually stable and easy to determine.

ii) Zero coupon bonds
- The bonds do not pay periodic interest hence the words 'zero coupon' bond.
They are issued at a discount and mature at par.
- Therefore, interest is accumulated and accounted for in the redemption value
of the bond.
- The lender is not locked into low fixed interest rate while the borrower does
not have fixed financial obligations of paying fixed interest charges.
- The liquidity of the borrower is not affected until the redemption date.
marto answered the question on February 8, 2019 at 08:44


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