Question

Explain the various components of the Bond? Provide an example

Answer 1

The various components of the Bond are –

Face Value or Par Value: It is the value which investors will get after the maturity of the bond. The value is stated generally $100 or $1000 per bond

Coupon Rate: It is the interest rate which is paid at period interval generally annual or semiannual. Coupon rate is stated in the percentage of the face value of the bond. For example 10% coupon rate means 10% of face value of the bond.

Maturity Period: Maturity period is another important component of the bond which states the time when the bond is going to mature and pay its maturity amount (par value) to investors.

Yield to maturity (YTM): YTM is market interest rate which is used as discount rate to calculate the market price of the Bond. If bond is selling at par, then YTM is equal to its coupon rate.

Bond’s Price: It is calculated by discounting all future cash flows from bond to its present value. YTM is used as discount rate.

For example, the Bond’s price can be calculated the help of following formula

Bond price P = C* [1- 1/ (1+i) ^n] /i + M / (1+i) ^n

Where,

M= The par value or face value of the Bond

P= Current price of the bond

C = coupon payment or annual interest payment

n = Time period to maturity

i = yield to maturity or priced to yield (YTM)