How to Calculate a Bond Price?

If you have traded in bonds or intend to do so, you may want to know how the mechanism of the bond price works. There are a few factors which may be affecting the ups and downs of bond prices. These factors include interest rates, terms of the bonds, bond ratings etc.

 

The price of a bond should not be mixed up with its par value. Bond price is the current market value of a bond, while par value refers to the amount of money the issuer of the bond need to pay the investors upon maturity of the bond.

 

How to Calculate a Bond Price?

  • Price of a bond could be lower or higher than its par value. When a bond is sold at market price which is lower than its par value, it is sold at a discount and vice versa if it is sold at a premium.

  • When you read price quotes of bonds in the newspapers or in any other media, the listing is indicating the percentage of market price of its par value. For instance, if you see the par value of a bond is $1,000 and the quote is 90.0, it means the market price is selling at 90% of its par value, which is $900 (selling at a discount); if at the same par value and the quote is 105.0, it shows the market price is selling at 105% of its face value, which is $1050 (selling at a premium)

  • The main factor affecting ups and downs of bond prices is interest rates. When interest rates are up, people are less incline to invest in bonds. As a result, the bond prices will usually drop. In contrast, if interest rates are down, people tend to invest in bonds, thus raising the bond prices.

  • Bond rating is another cause which determines the bond price. Bonds with high ratings are usually sold at a premium while bonds with low ratings are more likely sold at a discount. This is because the chances of default for high rating bonds are lower than the low rating bonds.

  • Terms of bonds would also determine how the bonds are priced. Usually bonds with shorter terms tend to price higher as they are less risky. On the other hand, bonds with longer terms are usually priced lower as they are riskier and more uncertain.

These are some references of how prices of bonds are calculated. The actual bond price calculation involves more complicated mechanism.

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