Bonds

When companies need to raise money, issuing bonds is one way to do it. A bond functions as a loan between an investor and a corporation. The investor agrees to give the corporation a specific amount of money for a specific period of time in exchange for periodic interest payments at designated intervals. These intervals are normally semi-annual. When the loan reaches its maturity date, the investor’s loan is repaid. 

Valuation of bonds

The current price is the present value of future cash flows associated with the bond. The present value is calculated using the yield till maturity as a discount rate. 


Example

A bond with a face value of $1000 having a three years maturity offers 10% interest annually. If the yield till maturity is 8% with is the market value of bond.

PV = ($1000 x 10%) x [1- (1.08)-3] / 0.08 + $1000 x (1.08)-3

PV = $992.74


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