Question

Explain in your own words how to determine the price of a Bond.

Answer 1

Manually calculating price of bond:

Bond price = Coupon / (1+Yield)^Year-1 + Coupon / (1+Yield)^Year-2 + ……. + (Coupon + Face value) / (1+Yield)^Year-n

Formula for bond value = PMT x ((1-((1+R%)^-N)) / R%) + (|FV|/(1+R%)^N)

Notations:

R = Rate or yield / frequency of coupon in a year =

PMT = Coupon rate x FV / frequency = Coupon

N = Number of years remaining x frequency =

FV = Future Value = Face value of bond

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The above equation discounts bond cash flows which is coupon from year to n-th year and final face value. The bond with no coupon will have only last n-th year cash flow in form of face value which can be discounted as: Face value / (1+Yield)^n

We know the cash flows of the bond which is predetermined but only information we don’t have readily is the yield of the bond. The yield of the bond is market factor. The yield is based on class of the bond and rating which the bond carries. Selecting an appropriate yield is an important factor and that can be done by mapping the given bond with existing classes of bond in market and rating for those class of the bond will have a yield mentioned in the market space. Data can be obtained from specialized online market portals (like Bloomberg).