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Financial Analysis

A bond’s yield is the measure of potential returns in assessing a security’s relative value. Yield to maturity concerns a bond’s internal tempo of return. Market participants who purchase and hold a bond’s yield to maturity while meeting scheduled future cash flows through coupons and principal payments earn interest rates. Yield to call is the interest earned when a bond is called, equating the bond’s current market price to present value of expected coupon payment and call price; it is applicable in callable bonds. Returns to investor often lower when a bond is called as the issuer always acts in the best interests of the company or government. Thus, they only call callable bonds when it is favorable – when the current market interest rate is lower. This is beneficial in retiring high rate debts while replacing them with lower rate bonds (Faboozi, 2009).

Bond ratings evaluate credit quality to provide essential information on the financial strength of a bond issuer and the repayment ability of both the principal and interest on time. They are graded by private and independent credit rating companies such as Standard and Poor’s, Fitch rating, and Moody’s. Ratings are expressed as letters with “AAA” and “C” representing strong repayment ability an eminent default respectively. Rating companies, however, can also use a variation of small and capital letters to distinguish themselves, affecting their ability to raise funds. This is because investors at adverse risk positions avoid firms with low scores. They also account for corporate and country ratings to seek investors’ guidance before investing in debt security. Thus, they provide transparent and independent information on the credit worthiness. Essentially, different bond ratings focus on bonds while country ratings focus on both short and long term debts, securities, preferred stock, loans, and insurance companies. Recommendations to buy are however omitted as indicators in willingness and abilities to pay debts are applied (Faboozi, 2009).

Common stocks or ordinary shares are forms of equity ownership in companies entitling owners to capital appreciation, dividends, and voting rights. During liquidation, holders have rights to company assets following compensation of bondholders, creditors, and preferred stock holders. Preferred stocks form partial equity ownership in a company. Unlike common stocks, they are entitled to preferential and greater claim to the company’s dividends as well as assets in case of liquidation. This is because preferred stock holders have to be paid dividends and assets after bondholders and other debt holders before common stock holders. They are also entitled to regular dividends if the company has the financial capabilities, while common stock holders have to rely on decisions made by board of directors. Thus, they neither fluctuate nor enjoy voting rights (Faboozi, 2009).

References

Fabozzi, F. J., & Mann, S. V. (2010). Introduction to Fixed Income Analytics: Relative Value Analysis, Risk Measures, and Valuation, Hoboken, N. J: Wiley.