What Determines the Stated Rate of a Bond?

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A number of interesting things go into determining the stated rate of a bond. Find out what determines the stated rate of a bond with help from a professional financial adviser in this free video clip.

Part of the Video Series: Insurance & Personal Finance FAQs
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Video Transcript

This is Teresa Dentino, CEO and founder of The Financial 411 in Woodside, California. We're talking about how the stated interest rate of a bond is determined. First of all, let's talk about what a bond actually is. It's really nothing more than an agreement between two parties where one is lending money to the other. In exchange for lending money, usually they are offered a certain interest rate for their investment. In this case, we're talking about the corporate world. Corporations will often raise money for projects by issuing bonds to investors. When they issue a bond, there is a stated rate of interest. There are several ways that this interest rate is determined. The first factor that's going to impact interest rate on the bond is the external economic environment. So, if we are in a period of low interest rates in general, the corporation that's issuing the bond is going to take its lead from what the prevailing interest rates are. The second thing that's going to impact how the corporation sets the interest rate is the corporation's actual credit history and credit rating. So, let's say we're talking about a corporation that has a very strong credit history and credit rating, and let's also say that current interest rates in the real world are around 5 percent. So the company with the strong credit history credit rating will essentially use that external rate, and their rate on their bond is much more likely to be right at that same level. Whereas, if you're talking about a corporation whose credit history is not as good, then in order to entice investors, they're going to have to offer a little bit higher interest rate as a sweetener. In the case where the investor is taking on a little more risk, of course, they expect to be compensated a little more higher than if they were not taking on the same amount of risk. This holds true in any investment, but specifically with bonds, that is how the stated rate of interest is determined. This is Teresa Dentino, CEO and founder of The Financial 411 in Woodside, California.


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