Bond Valuation

What is Bond Valuation?

Bond valuation is a method for calculating a bond’s theoretical fair market value. Calculating the present value of a bond’s future interest payments, also known as cash flow, and the bond’s value at maturity, also known as face value or par value, are both parts of bond valuation.

If the bond has embedded options, the valuation becomes more challenging and involves both option pricing and discounting. The calculated option price is either added to or deducted from the price of the “straight” component, depending on the type of option. The bond’s value is then calculated using this total.

Example of Bond Valuation:

$ V_{coupons} = \sum \frac{C}{(1+r)^{t}} $

$ V_{face value} = \sum \frac{F}{(1+r)^{T}} $

Relating to the symbols from above:
C = future cash flows or coupon payments
r = discount rate or yield to maturity
F = face value of the bond
t = number of periods or years
T = time to maturity

Example:

Let us assume a company XYZ Ltd has issued a bond having a face value of \$100,000, carrying an annual coupon rate of 7% and maturing in 1 year.

The prevailing market rate of interest is 9%.
Given, F = \$100,000
C = 7% * \$100,000 = \$7,000
n = 15
r = 9%
The price of the bond calculation using the above formula as,
FV = (7000+100000)/(1+0.09)^1 = 98,165

Why is Bond Valuation important?

When trading bonds with other investors, the price is crucial. The price of a bond is the amount of money that investors are willing to pay for an existing bond. Bond prices are expressed as a percentage of face (par) value in the online offering table and statements you get.