Bond valuation is the technique for evaluation of the fair value of a particular bond. It includes the calculation of the present value of the futuristic interest payments of the bond which is also termed as the cash flow and the value upon the final maturity (termed as par value or face value). The face value of any bond is fixed and so are the interest payments. Hence, the investors use this value for evaluation of the return rate for the bond or investment to fetch positive results.
It was estimated at the end of 2018 that the US bond market had a size of approximately $42.7 billion. Bonds provide a steady income to the investor in the form of coupon payments. At the time of the maturity, the whole face value of the bond is repaid to the investment holder of the bonds. The characteristics of a regular bond are:
- Coupon rate: The interest rate of the bonds is termed as the coupon rate. It is usually paid semi-annually to the bondholders. The coupon rate is the fixed interest given to the investor on a periodic basis until the time of maturity.
- Current price: The investor might purchase the bonds at par, above par or below par; as per the interest rate. The value of the bond will decrease with the higher interest rates as the coupon rate will be lower than the interest rate in the economy.
- Maturity rate: All bonds have maturity dates (long-term or short-term). At the time of the maturity of the bond, the issuer repays the investor the full-face value of the bond. The government bonds have an FV of $10,000 and for the corporate bonds, it is $1000.
Practical implementation of Bond Valuation
Bonds are a very essential part of the capital markets. This is the major reason that the analysts and the investors look forward to understanding their features for interaction for determining their intrinsic value. The value of a bond determines the suitable investment for the portfolio and it is a major step in their investment. Bond valuation is the real calculation of the present value of a bond expected future coupon payments. Theoretically, the fair value of a bond can be calculated by discounting the price of its coupon payments by the right discount rate. Calculation of the value of a coupon bond gives annual or semi-annual yield for the cash flow and the par value of the bond.
Zero-Coupon Bond Valuation
A zero-coupon bond makes no semi-annual or annual payments for the bondholders. It is calculated only by finding the present value of the face value of the bond. The difference between the purchase price and par value would be the investor’s interest attained on the bond.
Bond valuation is the way to determine the par value (theoretical fair value) of a particular bond. It includes the calculation of the present value of the expected future coupon payments or the cash flow and the maturity value of the bond (face value). By calculation of bond valuation, the investors can figure out the rate of return made by a bond investment worth the costing.