Bond valuation and risk assessment in pharmaceutical companies

¶ … Bond

In general, the price I would pay for this bond will depend on the risk that the company has. My personal risk preference is that I am risk averse. I expect inflation to continue to be very low over the next year, but increasing slightly from current levels. The prevailing interest rates are low, which means I would expect the corporate bond rates to also be quite low. The company I have selected is Johnson & Johnson, and I do not believe that there is any default risk with this company. They are a large, stable company with a large cash position and stable earnings. They have a wide range of products, meaning they are well-diversified. In addition, that company has increased its earnings steadily over the past several years. They compete in a number of different industries as well. Thus, there is little risk that Johnson & Johnson will default on its bond. I see this as a positive, and as a result I am willing to pay less than $1,000 but I would not need to pay significantly less.

I would pay $950 for this bond.

2. The discount rate for this bond can be calculated based on the amount I would pay, the time frame of the bond and the face value.

The basic formula is:

PV = FV / (1 + r) ^ t

If we assume that the face value of the bond is $1,000 and the time frame is one year, then the formula would be as follows:

950 = 1000 / (1 + r) ^1

950 * (1 + r) = 1000

950r + 950 = 1000

950r + 950 -- 950 = 1000-950

950r = 50

50/950 = r r = 5.26%

3. JNJ competes in the drug industry. There are a number of competitors in this industry. There are few firms in this industry that are more stable than JNJ. Merck is a very stable company with excellent cash flow and some good products. I would perhaps pay slightly more for the Merck bond than I would for Johnson & Johnson. In this case, I would pay $960 for the Merck bond.