A Basic Bond Valuation Calculator
A bond is essentially a loan made by the bondholder to a government, government agency, or a corporation. Under the agreement, the lender and borrower outline the periodic interest payments the lender will receive during the life of the bond and the timeframe to repayment of the original amount or “principal”. The duration of the bond agreement (the maturity) varies, from several months or less to several decades. What makes a bond different from other debt securities is that its value can fluctuate during its life and it can be bought and sold on a secondary market.
Who Issues Bonds?
The three main categories of bonds include:
• Corporate
• Municipal (issued by a state of local government)
• Treasury (issued by the federal government)
Corporations issue bonds as a way to borrow large amounts of money. Corporate bonds are typically offered in $1,000 denominations and can be offered with very long maturities. Governments and governmental agencies also issue bonds to raise money; U.S. Treasury bonds being the most secure as they are backed by the “full faith and credit” of the U.S. government.
Bond Terminology
In order to price and invest in bonds, you need to become familiar with the following basic terms:
• Maturity is the life of the bond; the length of time before the par value is returned to the bondholder. The maturity can run from several months or less to several decades.
• Par value or face value is the amount the bondholder receives at maturity.
• Coupon or yield refers to the interest rate paid by the bond. While some bonds offer a variable rate that is tied to some index, the coupon rate is typically fixed.
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The Bond Valuation Process
To assign a present value to a bond, an investor would discount the bond’s expected cash flows to a present value. The discount rate used will depend on the current interest rates for debt instruments with similar risks and maturities.
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The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.
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