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

value of bond is determined by discounting the future cash flows to the present by using discount rate. Four major factors which will show impact on the bonds prices are Supply, Demand, Credit ratings and age to maturity.

Formula for Determining the price of bond is

C- Coupon Payment

t- time

F- face Value

y- Yield to maturity

T- Number of Periods until the bonds maturity date

In general Bonds prices are majorly impacted when there is a change in interest rates, if interest rates are raising the prices of the existing bonds will fall due to lack of demand for older bonds.

If interest rates are falling the prices of the existing bonds will increase due to increase in demand for old bonds

Rate of Interest is used to discount the cash flows to know the bonds price

Prices and yields are inversely proportional

Bonds coming with higher interest rates are priced higher due to increase in demand and vice versa

what ever it may be the price but at the time of maturity the prices will comes to face value. Due to change in interest rates the prices of bonds will increase or decrease up to only one level apart from that level the prices will start reversing to wards their face value because at the time of maturity bond holder will get face value only paid by the issuer.

prices of the bonds will increase faster when the interest rates are falling but when interest rates are raising the bond prices wont fall that much faster, this effect is called bonds Convexity

we can compute how much variation will come in bonds prices when there is a change in interest rates by using Modified duration Concepts

If a bond holder holds bond till it's maturity the holder will get coupon payment only he won't get any capital appreciation