Bond valuation means a determination of the fair price of a bond by calculating the amount that you have paid for the bond. In capital speculation, the fair value of a bond is taken as the current worth of the stream of cash flows the bond is expected to generate. It is really easy to get the authentic value of a bond by discounting the predictable cash flow to the current value in the presence of a suitable discount rate. The discount rate is resolute in the orientation of similar instruments. If the bond features entrenched options then the evaluation can be tricky with the mixture of option pricing and discounting. Option prices calculated according to the nature of the option can be added or subtracted from the price of the straight portion. The value of the bond can be calculated based on the market rate and interest on the evaluation of the declared rate of interest.
There are three options to sell the bonds in the market, either you can sell them on par value, below par value, or above par value. It depends on the market condition, if the market rate is more than the stated rate then you have to sell it at discount and if the stated rate is more than the market rate then you will sell your bond at a premium. For instance, $500,000 bond matures in five years with an avowed interest rate of 10 percent and the market interest rate is 6 percent then this bond will pay interest semi-annually.
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Basic Bond Valuation Tips
You can easily perform basic bond valuations by below mentioned tips and techniques:
- In the first step, you have to determine the present value of the dollar to know about the maturity of the face value of the bond. For instance, on the present value of $1, use 4 percent as the interest rate and 10 as the period. Divide interest rate in half for semi-annual or twice-per-year payments. Now 4 percent dividend in half is 2 percent. Multiply the period by two because it is semi-annual which means it will pay you twice a year. For example, 5 times 4 equals 20. The factor for the table is 0.81253.
- Now multiply the face value of a bond with its present value of the $1 factor determined in the above-mentioned step. Multiply $500,000 x 0.81253 = $40,626.5
- Calculate the interest earned on each payment by multiplying the face value of the bond with the stated interest rate per month. For example, $500,000 times 5 percent equals $25,000.
- Now it is time to calculate the present value of an annuity factor for the interest payments. For example, 4 percent is for 10 years. The present value is $1 so the present value of the annuity factor is 8.9826.
- Multiply the interest payment with the payment value of an annuity factor such as $25,000 times 8.9826 equals $224,565.
- Add the present value of the bond to the present value of the interest payment to get the exact amount such as $82,035 plus $224,656 equals the bond value of $306,600.
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