How matching the Security to Variable Interest Rate looks like? The mechanism of matching the security of a fixed rate to a variable interest rate prevailing in the market will be presented on the example of German bonds occurring in the developed capital market. When making the type of investment like bond purchase you must determine what income is obtainable. Defining profitability is crucial in making an investment decision. Bond yields are affected by the following values:
– bond rates,
– the nominal interest rate on bond,
– market rate,
– the period remaining to the redemption of bond,- the face value of the bond.
In this system, there are only two constants: the nominal interest rate of bond and the nominal value of bond (taking into account the technique of administration of courses the face value is of secondary importance). Other sizes are variable.
Rate of exchange bonds can be administered in the form of percentage points as the ratio of the nominal exchange rate to its value (eg, 102% of the nominal value or 94%). The share price, which is the current price of a bond may deviate from the nominal price of the bond. This is explained by the relationship: the market interest rate and the nominal interest bond rate, and the period remained till repurchase of the bond. It is affected also by a risk factor. The market interest rate is the rate of interest prevailing in the market today. This is the rate that each participant in the market – the investor is trying to actually achieve as remuneration for the capital lent or market participant – the borrower is willing to pay as the cost of obtaining capital for the time of use.
The nominal interest bond rate and the nominal price is fixed (the nominal price = nominal value). In this configuration, there must be a mechanism that causes the bond with a fixed interest rate and a fixed nominal value is attractive in changing conditions in the capital market. Then the bond buyer must pay more than its face value, because the former owner of bond may be realizing higher percent than the market interest rate. Resignation of such bond is rewarded with a higher price paid during the sale.
It can also be reversed. Then the buyer will pay the lower price for bond (exchange rate) than the face value, because in this way he’ll compensate the insufficient amount of a nominal bond value by which he receives income from the bonds of the issuer. Otherwise, the purchase of bonds would be unprofitable. The investor would further fulfill the nominal percentage lower than that which he could achieve by making other investments in the market and getting the interest market rate, which is currently widely achieved. Thus, a mechanism that allows the “matching” of the bonds to market fluctuations is the determination of its the current price. If the rate is higher than the nominal value, there is a bonus in this case. If the value is higher than the nominal exchange rate then in this case there’s a discount.