BOND VALUES

The value of the bond can be determined using the discounted cash flow analysis. For a level coupon bond, the cash flows from the bonds which take place over the term of the bond include face value, and coupons. The other details required for valuation include the number of periods remaining until maturity, and the market interest rate for bonds with similar features. This interest rate required in the market of a bond is called the bond's yield to maturity. In short, this is also known as bond's yield. Using the cash flows, the present value of the cash flows can be determined which is an estimate of the bond's current market value.

Let, F be the face value paid at maturity; C be the coupon paid per period; t be the periods to maturity; and r be the interest rate per period, the cash flow diagram (Figure 1) is given below:

Figure: 1 Cash Flow Diagram of a Level Coupon Bond

The value of the bond gives an indication of the price at which the bond should be sold in the market. Under favourable circumstances, the bond value could be equal to the face value. In this case, the bond can be sold in the market at the face value, then it is called premium bond. In case, the bond is sold at a price lesser than the face value, then it is called discount bond.