Showing posts with label interest rate. Show all posts
Showing posts with label interest rate. Show all posts

Tuesday, February 21, 2017

Is there a Legal Cap on Bond Rates?

Picture portrays bond and wonders about rate cap
Picture portrays bond and wonders about rate cap 

Actual Question:

What is the maximum interest rate and minimum interest rate for issue of debentures?

Answer:

Dear Friend!
There are no laws or regulations that fix the minimum and maximum interest rates for debentures or bonds; it is the market that determines them.
The debenture is a debt contract and the interest rate is one of the contract terms. In a contract it is the mutual consent and acceptance that matters.
In reality the interest rates of debentures are governed based on following factors:
  • Is it a government debt?
  • If private debt is there a sovereign guarantee?
  • Is it a secured or unsecured?
  • What is the tenure or repayment period - short or medium or long?
  • Credit Rating assigned by independent rating agency
  • What are the prevailing market interest rates for similar instruments?
  • What is brand value of the issuer - example TATA Steel
  • There are many other factors that go into finalising the interest rate of the debenture. Finally whether the rate will be attractive to the investors and affordable to the investor are the key.

Thank you,
With Best Regards

Anand

Related:



Tuesday, December 27, 2016

What is the Difference Between Rate of Interest and Rate of Return?

Interest Rate:
Interest rate is the promised or specified or coupon rate of interest payable on the principal amount of the loan or the nominal value of the instrument like a bond or a fixed deposit.

For example let us consider the following picture of 9% Treasury note of the US:
Picture of 9% US Treasury Note indicating the nominal value and rate of interest
Picture of 9% US Treasury Note indicating the nominal value and rate of interest
In this example:
  • The principal or nominal value of the instrument is US$ 1000
  • The coupon rate or rate of interest is 9%
  • The annual interest receivable is US$ 90

Rate of Return:
Rate of return is the actual rate actually obtained or earned by the investor on the investment.
Can there be a difference between interest paid and actually earned by the investor? How is it possible?
Yes, indeed it is possible.
How?
Because there is what is called a secondary market for bonds, treasury notes and various other kinds of debt instruments, where these are sold at prices different from the nominal value.
For example the “9% US$ 1000 Treasury Note” can be trading at either US$1100 or US$ 800 depending on the market demand and supply. Let us examine two situations where the note is bought at US$ 1100 and 800.
Bought at US$ 1100:
  • The principal or nominal value of the instrument is US$ 1000
  • The coupon rate or rate of interest is 9%
  • The annual interest receivable is US$ 90
  • Actual cost of investment is US$ 1100
  • Interest rate actually obtained or earned by the investor is (US$ 90/ 1100)*100 = 8.18%
  • Rate of Return therefore is 8.18% and not 9%

Bought at US$ 800:
  • The principal or nominal value of the instrument is US$ 1000
  • The coupon rate or rate of interest is 9%
  • The annual interest receivable is US$ 90
  • Actual cost of investment is US$ 800
  • Interest rate actually obtained or earned by the investor is (US$ 90/ 800)*100 = 11.25%
  • Rate of Return therefore is 11.25% and not 9%
  • This rate of return actually obtained is also called the yield .

Suggested Further reading:



Thursday, November 3, 2016

How to Calculate Rate of Interest from Actual Ineterst?

Interest is computed by applying rate of interest on the principal. If we have the principal and actual interest, we can derive rate of interest by dividing the interest by the principal and multiplying the result by 100.

Following example make things clear:

Calculation of Interest with rate of interest:

Formula:




Rate of interest to calculation of actual interest:







Interest (I)
=
Principal × Rate of Interest








Example:




 Example A
 Example B
Principal
 25,00,000
 100
Rate of Interest
10%

Actual Ineterst
 2,50,000
 10

 


Calculation of Rate of Interest from interest and Principal:

Formula:




Example 2







Interest



Rate of Interest
=
×
100



Principal




Example:


Actual interest to calculation of rate of interest:


Principal
 25,00,000
 100
Actual Interest
 2,50,000
 10
Rate of Interest
10.00%
10.00%