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Bond Valuation

There is an inverse relationship between the coupon rates and the bond prices when: Interest rates rise, leads the income rise, whereas the price of the bond declines. Interest rate decline, leads the income decline, whereas the price of the bond rises. Also keeping one thing in to consideration is that the coupon is inversely related to duration because higher coupons lead to quicker recovery of the bond’s value, resulting in a shorter duration, relative to lower coupons.

If coupon rate is > market rate then it is favorable for issuer and if coupon rate is < market rate then it is favorable for purchaser. The reason behind the variations in the coupon rates of various bonds is the market interest rate; company’s performance, time length, and credit worthiness of the issuer so all these factors have an implication on the bond yields (Marcus, 2001). It is the thumb nail rule in the bond market is that when ever the interest rates rise, bond prices tend to fall, and when rates fall, bond prices tend to rise.

This is primarily occurred due to the economic condition of the country and also because of the market sentiments. If the price of the bond goes down it is less attractive (pays less interest) in comaprison with current offerings and when the price of the bond goes up it is more attractive (pays more interest) in comaprison with current offerings or describe in a sense that when the coupon rate is > market rate then it is favorable for issuer and if coupon rate is < market rate then it is favorable for purchaser..

Some bonds sold below the par value means (at discount) or more than par means (at premium). This is occurred due to the risk perceived for the debt of the particular organization . Market interest rate fluctuations usually on the performance of the secondary market where the bond is traded. Federal bank monetary and fiscal policy, inflation rate, recession in the economy, etc are the factors that forced to sell the bonds at discount or at premium.

Remember sell of bond on discount or at premium also have some impact on the yield and also the maturity factor, the shorter a bond’s maturity, the less its duration. Bonds with higher yields also have lower durations. Also the company’s performance makes reflection on the bond valuation like its bond ratings, bond covenants and credit worthiness etc. If the Investors approach is negative towards the company’s bonds it increases the probability of selling primarily due to the company’s performance or credit rating than the company tend towards the selling of bond at bargain (Marcus, 2001).

C = coupon payment (Marcus, 2001). n = number of payments i = interest rate, or required yield M = value at maturity, or par value CALCULATION OF BOND PRICE Face Value = 1000 Coupon Rate = 10% Period = 5Years YTM = 12% Bond Price = (0. 10*1000)/ (1+0. 12)1 + (0. 10*1000)/ (1+0. 12)2 + (0. 10*1000)/ (1+0. 12)3 + (0. 10*1000)/ (1+0. 12)4 + (0. 10*1000)/ (1+0. 12)5 + (1000)/ (1+0. 12)5 Hence the Bond Price = $928 REFERENCE Brealey, Richard A. , Stewart C. Myers, Alan J. Marcus (2001). Corporate Finance. McGraw-Hill.

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