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International Business Finance

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Introduction

Bonds are one of the main capital market securities in positions of debt finance. Bonds are financial assets that can have the maturity time of one to thirty years. Investors can decide a fixed time period for the transaction. These different types of financial securities have distinct financial claims. Claims can be either fixed or variable interest rate or a form of dividend. Bonds are delivered for its face value and investors are eligible to a stream of coupon value. Various types of bonds which paya fixed coupon over decided period to maturity redemption, including a return principal on the maturity date. “Riskiness and yield often reflectson the preference of financial securities. Equity holders require a premium to compensate for their exposure to the additional capital risk and greater uncertainty over the future payment, thus the return of Equityfinance higher than the debt finance comparatively” (Pilbeam, 2010) Shares can be the riskiest investment to hold because of the uncertainties in the market and the return of dividend and the forthcoming payments are unpredictable. Having high difficulties in calculating the net income due to high volatile market. Shares are mainly to invest in organization’s capital and number of shares divided to unit of the organization’s value. Conversely, Faerber(2009) declares that investing in bond gives you more security and less risk to your investment. This report analysis shows you what type of investments are more secured and significant at these economic Conditions.

01. Bond Market

Bonds are issued in order to manage the national debt. You lending your money to an organization or to the government and after the agreed time period you’re your amount in full with the interest. (Kansas2005). There few types of bonds in the current market. A government bonds is fixed and it pays in regular interval (Redhead, 2003). Government bonds are the mosttrustworthy bond among all bonds. Investor can be confident about the yield of the government bond because government can print the notes if it had to repay the yield. Government bonds are safe as cash to the investors. Most suitable bonds for the Investors who consider on more safety and fixed income are treasury bonds. Corporate bonds are issued by the private companies in the market, it gives you a higher return than government bonds but corporate bonds are unsecure than government bond.

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Standard bonds pay its interest on monthly basis, quarterly basis or annually based on the capital amount that investor invested. Junk bonds are risky investments because companies that issue junk bonds have less than less credit rating but they offer high return. Recent changes in the financial securities have makes investors’ attention towards investing on financial securities more serious. Bonds are one of the main financial securities. Economic influences have a greater impact on investment instruments. Growth of the economy is 0.7% throughout the first quarter of2014 and banking interest rate below 1 in past year and so far this year. Inflation rate in 1.7% which is lowest in four years. So these economic factors could affect to investing decisions. (Sources: BBC business).

02. Share Market

A share is a unit of ownership of a company, which is on offer for investors. The value of the company is divided into units of same scope. Those units called as shares. As the value of company fluctuates, share price of company fluctuates as well. More the company grow is more beneficial for company. Because investors can sell their shares to a higher price they bought. Share price reflects with the change of the economy such as economy recession. “There are two types of shares, ordinary shares and preference share. Ordinary shares represent partial ownership of company and preference shares entitled to given the dividend.Preference share holder will be paid prior to the ordinary share holder inthe event of liquidation”. (Pilbeam 2010). Current equity market is cheaper when comparing with bond market in UK.

03. Risk in Bond and Share Market

3.1Risk Associated in bond and Equity Market

Authors stated that existing equity price is reliable with future returns are not far from significant standards. Even economic factors affect the volatility in forthcoming years Predicted yield on both equities and bondsare expected to remain high.

3.1.1 Interest rate riskChanges in interest rate often play a vital role. All the investors wantedto be on the safer side. According to authors High quality bonds fill seriously in efficient portfolios. As interest rate fall and weakening

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profitability while economy in recession destined. Relationship between interest rate and bond price is inverse people would invest money in banksrather than invest on financial securities. Price of existing bond rises if interest rate fall and price will decrease if interest rate goes up. (Williams 2009). Changes in interest rate prices can affect share prices as if the risk premium is accord interest rate rises discount rate will raise. More higher the discount rate will decrease the stock price.

3.1.2 Default Risk

According to authors when investing investors heavily rely on credit ratings of organizations. Credit rating describes the issuer’s ability of service and pay back. With a struggling economy, UK tends to have a slow growth in economy and that led the country to downgrade its rating from AAA to AA1 (Moody’s report2013). According to authors down grade in ratings could affect bonds in long term borrowing cost. Company with low credits proves that companies’ ability to pay back is less.

3.1.3 Inflation RiskInflation is the strongest impact on bonds; inflation erodes the buying power of a bonds future cash flow. The higher the current rate of inflation and the higher the (Predicted) future rates of inflation, Yieldswill rise through the yield curve, as investors will demand this higher yield to compensate for inflation risk. Examining historical returns on data during both high and low inflation provide clear idea. Most studies have given that inflation can affect in both positive and negative ways. According to authors greater stock movements was correlated with higher inflation.

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Above graph explains that almost every country suffered with worst return during high inflation. Real returns are actual returns minus inflation. Above results suggest that highest returns occurs when inflation is between 2 to 3% if inflation greater than that could have more impacts on returns.

3.1.4 Systematic and unsystematic riskSystematic risk unsystematic risk is integral and cannot be spread and canassumed to be rewarded in market place. Unsystematic risk can expanded in well managed portfolio and can be rewarded with high returns. (Geoffrey and Stanley 1996). Systematic risk is uncontrollable by an organization and unsystematic risk is controllable by an organization. "Portfolio diversification is the process of investing money in range of a different securities and assets within the aim of reducing risk ( Pilbeam, 2010).

04 Advantages and disadvantages of Bond Market

4.1 Advantages of BondsAccording to authors steadiness and safety is guaranteed if you invest in bond market. Bonds give you regular incomes. Return of the capital you invested is guaranteed at the end of the maturity. By investing in binds you get the agreed interest rate throughout the coupon time period. Past researches suggest that bond market is less volatile when comparing to anyother finance security market. Bond investors get reliable income, tax exemption, higher income and less volatile. (Renberg 1995).

4.2 Disadvantages of BondsBond prices can change with the credit ratings of the issuer. Downgrade incredit rating can affect the market price of the bond, but not the interest payment. Risking the market price can affect to mutual fund holdings these bonds, and individual bond holders may have to sell the bonds.

05 Advantages and Disadvantages of Share Market

5.1 Advantages of Share Market

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Investors who are investing on shares, investing with an intention of profits of short time period. Investors need to select a productive investment to gain profit because when the share price rises they can selltheir shares and gain the profits.

5.2 Disadvantages of Share MarketAccording to authors it proves that investing on bonds are safer than investing on shares. Main reason for that is the return is unexpected and it depends with the companies performances. Another difficulty of gaining profit is the high variations in the market price of shares. Last stake holder to get dividend and capital investment is shareholder.

Conclusion

As above details shows both financial securities that we examined give benefits and profits to investors, but it proves that share can be more riskier with a small fluctuations of the market, bonds are not riskier than shares because bonds has estimated value and its predictable for theinvestor. Before investing investors need aware of the interest rate, economic factors, inflation rate etc. Currently investing appears to be inan overweighed position for investing specially for equities. But for it’sunderweighted. UK government bond yields have fallen down for past few years but some decent returns are still available from corporate bonds, average for the corporate bond return is 1.6% P.A. Investors who don’t want to be stuck in for a long time with their money they can invest on secondary bond market. So the conclusion of this report with above evidence clarifications bonds is less risky to invest in the current economic climate.

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Appendix

Figure 01 (Source: Bloomberg)

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(Source: Bloomberg)

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