Analysis for Financial Management
User Rating: 0 / 5
- Details
- Hits: 10994
According to Higgins (2016), a fundamental financial notion holds that funds in the present merit more than an equal amount of cash hereafter. That is realistic as one can invest money at hand and earn revenue, therefore gaining a substantial amount of funds. Additionally, future money has an additional risk in that one may never receive the money for different reasons. The following scenario fits in elaborating further on the concept of the time present value of money.
I just won the lottery jackpot of $11,000,000. I will receive the payment in 26 equal annual installments beginning immediately. If I had the money now, I could invest it in an account with a quoted annual interest rate of 9% with monthly compounding of interest. Therefore, the present value of the payments I will receive will be according to the following formula.
PV=P x [1+ (i/n)] ^ (n x t)
Where:
PV= Present value
P= Principal amount before investment if I have all the money at once.
i= the interest rate at which I will earn a return on the money after investing in an account
t=the number of years I will take to receive the 26 annual installments
n=the total number of compounding intervals of interest per annum.
Considering the formula above, the present value of the payments I will receive will be as follows
PV=$11,000,000 x [1+ (9/12)] ^ (12x26)
It is noteworthy that figure 312 is a multiple of 12 months in a year, and the 26 years it would take me to receive all the 26 installments for the sum of $11,000,000.
PV=$11,000,000 x [1+ 0.75)] ^ (312)
PV=$11,000,000 x [1.75)] ^ (312)
PV=$11,000,000 x 6.727770839x1075
PV=$7.400547923x1082
Bond ratings
AAA bond rating
In comparison with BBB, CCC, and D, AAA bond rating is the uppermost rating that prime credit rating agencies would assign to bonds for an issuer. Fitch Ratings and Standard & Poor’s use AAA ratings similarly to Moody’s use of “Aaa” in signifying a bond’s highest tier credit rating. This type of bond has extremity of affluence as the issuer of AAA bonds meets financial commitments without difficulty, and their probability to default is the lowest. Therefore, AAA bonds have the best credit quality (Stadnik, 2018).
The strength of this bond rating is that investors view it as the least probable to default, which implies that its issuers easily find investors.
The major weakness of the AAA bond rating is the low yield the issuers offer in comparison with other tiers (Stadnik, 2018).
BBB bond rating
While AAA bond rating refers to high credit quality and CCC, and D low credit quality, BBB investment grade is a medium credit quality rating.
BBB bond rating has strength in that it constitutes a reasonable low-risk investment, and a bank can invest in the bonds (Stadnik, 2018).
This bond rating has a weak point in that, although a company with a BBB bond rating predominantly exhibit the capacity to meet debt payment commitment, such an organization is "speculative grade" and got a high vulnerability to uncertain economic conditions, unlike for a company with AAA bond rating. BBB bond rating is, therefore, near the lowest among investment bond ratings and only surpasses junk bond ratings like CCC and D by only two grades. It is, therefore, fit for any risk-averse investor to be cautious about BBB investments, in particular, if the rating recently experienced a downgrade (Stadnik, 2018).
CCC bond rating
S & P and Fitch organizations use this credit rating for investments. It constitutes an immensely high-risk bond in which the law prohibits the banks from investing. Unlike AAA and BBB bonds, CCC bonds fall under the category of junk bonds with a disadvantage of low rating as they have high risks of default by the issuer, which is a weakness. CCC bonds are highly speculative with an indication of default or substantial doubt that the issuer would pay either interest or principal (Stadnik, 2018).
Some of the strengths of CCC bonds are that they possess higher yields since they have a higher risk than AAA or BBB bonds and are therefore most relevant for risk-aligned investors. The issuers of CCC bonds offset the risk by giving significantly higher interest rates than on AAA or BBB bonds (Stadnik, 2018).
D bond rating
D Credit bonds depict the worst risk and do not fit any investment grade as the concerned agency is already on the list of defaulters. Standard & Poor's and Fitch accords D bonds the lowest rating with an equivalent rating as C as Moody's provides. Therefore, D bonds also fall in the category of Junk bonds because of their ultimate risk and their unpopularity among investors (Partnoy, 2017).
Due to their credit ratings, D bonds lower the issuer’s ability to borrow funds, as they do not mostly appeal to venture capitalists, particularly in comparison with investment-grade BBB and above, which is a weakness (Partnoy, 2017).
The only strength with D bonds is that they benefit agencies that cannot any longer deliver their debt adherence on time. An agency that is virtually indubitable that it will default on its debt commitments has a chance to benefit from D bonds (Partnoy, 2017).