How to Calculate a Bond Price
Governments and corporations issue bonds when they want to raise money from public for diverse purposes. The difference between bonds and other kinds of loans is that these can be traded like stocks. As such, the price of bond is generally not the same as its face value. New investors may find it a bit confusing.
Every bond carries a face value and a predefined rate of interest, also known as coupon rate. Most often corporate bonds have a face value of $1,000, meaning that is the sum of money that the issuer pays to the holder of the bond on its maturity. The interest or the coupon rate, as promised, is generally paid twice per year. Bond price could either be more and thus sells at a premium or less (discounted price) than its face value. The bond price and the coupon rate it carries are taken into consideration for calculating its actual yield.
Bond prices keep changing regularly and you may access the same through newspapers, financial magazines and publications such as the Wall Street Journal and through the Internet that has many sites for the purpose. Usually, bond price it is indicated by a number, expressed as a percentage of its face value. A number say, 88.5 indicates that the bond is available at 88.5% of its face value. That means a bond issued for $1,000 is available in the market for $875.
Those investing in bonds keep a track of the rates of interest because this affects bond price most significantly. When the interest rates are high, buyers would not be inclined to buy it, as a consequent of which it price is likely to fall, meaning the yield goes up as buyers get paid interest at the same rate, though investment is smaller. The opposite happens when rate of interest falls.
Apart from the market rates of interest, bond price is affected by other factors. A short term bond with a maturity period of one year is naturally not so risky as another bond with a maturity period of say twenty years because it’s difficult to predict market rates of interest for so long a period. Another important consideration is the creditworthiness of the bond issuing entity. Financial services like Moody’s rate bonds. Bonds carrying AAA rating are least risky. Bonds that are risky are rated below AAA, like AA or AA+.
If you intend investing in bonds, you should learn calculating yield of a bond. Since the coupon rate remains unaltered for the duration of the bond, yield is calculated by dividing the coupon rate by the amount paid for buying the bond and stating the result as a-percentage. In fact, you can easily calculate yield of a bond using bond yield calculators, of which many are available online.