Hi All
For me, it is clear that how I can earn money from equity trading. I buy undervalued equity and sell when it’s price goes up. Whenever a company earning result is announced, I reevaluate the equity value. While the valuation a person knows if he has to sell or buy.
On the other hand, Bond value is fixed. (Bond price is variable depend on interest rate change. but it does not bring any exogenous value compared with equity valuation) I mean it is not changeable because bond price is a sum of discounted coupons and a matured face value. In a equity case, if a FCFF or FCFE increases, I assume that there is a value creation (i.e. a company has achieved value). However in a bond case, I do not see any extra expected future value creation, as coupon amounts and maturity amount are defined.
I wonder why banks and financial institutions buy and sell the bonds.
Thank you
heavenkid
Well, the value of the bond is a function of its expected coupon payments, which a known in advance, in case of fixed coupon bond and interest rates, which depend on the level of threasury yield and credit spreads. If company investes in projects, which have positive NPV they increase FCFF or FCFE which in turn has positive effect on its stock price (you´re right) but this also leads to the price appreciation of its bonds, since default risk is lower and therefore investors require lower compensation for credit risk which translates in lower credit spread. Hower the price appreciation potential of the bond is obviously limited ( the sum of undiscounted coupon payments and par). So you can say positive NPV projects lead to price appreciation of both equity and bonds, but in the first case apreciation potential is unlimited and of bonds is limited.
Regards
Bonds are fixed income securities. Therefore, their “value” depends mainly on interest rates. So factors that affect interest rates (risks) will have the greatest input on the value of a bond.
Equities cashflows are variable by nature; whether FCFF or FCFE. Therefore, equity value is affected by not only interest rates but also by cashflows.
Investors usually buy bonds in anticipation of a decrease in interest rates, so that they gain when interest rates decrease, and vice versa.
Corporate bonds are traded on a relative value basis, not as a bet on rates. One would tend to buy a bond that is viewed to be undervalued by the market, e.g. the yield being offered is outsized relative to the perceived risk of default. An investor would typically only sell bonds to meet unanticipated liabilities or to take advantage of (relatively) more favorable opportunities, assuming their fundamental view remains unchanged.