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Hi John
‘In relation to an irredeemable security paying a fixed rate of interest’
As risk rises, the market value of the security will fall to ensure that investors receive an increased yield.
I understand that as risk rises the investors will require a higher return to compensate for the increased risk but would you mind explaining why the MV of the security will fall?
Thanks
GrahamThe MV of debt is the present value of the future receipts discounted at the investors required rate of return. If we discount at a higher rate we end up with a lower present value.
Or, if it makes it more obvious, it you were investing in debt that was paying fixed interest of $5 per year and you wanted that to be a return of 10% then you would be prepared to pay $50.
If alternatively you wanted the return to be 20% but we still only going to get $5 per year, then you would only be prepared to pay $25 ($5 per year is a return of 20% x $25).
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