Question

What determines the value of a bond? Write down the formula for determining the price of the bond and explain it briefly?

Answer 1

The value of a bond is the sum of it's discounted cashflows.The value of a bond is affected by it's rating, yield to maturity and market interest rate .Bond ratings serve as an indication of the bond's credit worthiness.The higher the rating of the bond the lower the interest rate it carries. Junk bonds have lower ratings.The ratings are often given by independent rating agencies like Standard and Poor's ,Moody's Investor services etc.Yield to maturity is the actual rate of return the bond offers from it's purchase date to it's maturity date.Yield to Maturity=(Coupon+Face Value-Price)/Number of years /(Face Value + price) /2.The bond price has an inverse relationship with market interest rate .As the market interest rate rises the bond price declines.

Formula

Value of bond=I*(PVIFA)+F*(PVIF)

I=Interest in each time period.PVIFA is the present Value Interest Factor of an Annuity at a given discount rate(market rate) and for specified number of periods.F is the principal or face value of the bond PVIF- Present Value interest factor.

Steps can be summarized into three

1)Calculate the PV of interest payments at market rate

2)Calculate the PV of face value at market ate

3)Add the two PV's