Business Finance Online

Bond Valuation


Bonds are long-term debt securities that are issued by corporations and government entities. Purchasers of bonds receive periodic interest payments, called coupon payments, until maturity at which time they receive the face value of the bond and the last coupon payment. Most bonds pay interest semiannually. The Bond Indenture or Loan Contract specifies the features of the bond issue. The following terms are used to describe bonds.

Par or Face Value
The par or face value of a bond is the amount of money that is paid to the bondholders at maturity. For most bonds the amount is $1000. It also generally represents the amount of money borrowed by the bond issuer.
Coupon Rate
The coupon rate, which is generally fixed, determines the periodic coupon or interest payments. It is expressed as a percentage of the bond's face value. It also represents the interest cost of the bond issue to the issuer.
Coupon Payments
The coupon payments represent the periodic interest payments from the bond issuer to the bondholder. The annual coupon payment is calculated be multiplying the coupon rate by the bond's face value. Since most bonds pay interest semiannually, generally one half of the annual coupon is paid to the bondholders every six months.
Maturity Date
The maturity date represents the date on which the bond matures, i.e., the date on which the face value is repaid. The last coupon payment is also paid on the maturity date.
Original Maturity
The time remaining until the maturity date when the bond was issued.
Remaining Maturity
The time currently remaining until the maturity date.
Call Date
For bonds which are callable, i.e., bonds which can be redeemed by the issuer prior to maturity, the call date represents the date at which the bond can be called.
Call Price
The amount of money the issuer has to pay to call a callable bond. When a bond first becomes callable, i.e., on the call date, the call price is often set to equal the face value plus one year's interest.
Required Return
The rate of return that investors currently require on a bond.
Yield to Maturity
The rate of return that an investor would earn if he bought the bond at its current market price and held it until maturity. Alternatively, it represents the discount rate which equates the discounted value of a bond's future cash flows to its current market price.
Yield to Call
The rate of return that an investor would earn if he bought a callable bond at its current market price and held it until the call date given that the bond was called on the call date.

The box below illustrates the cash flows for a semiannual coupon bond with a face value of $1000, a 10% coupon rate, and 15 years remaining until maturity. (Note that the annual coupon is $100 which is calculated by multiplying the 10% coupon rate times the $1000 face value. Thus, the periodic coupoun payments equal $50 every six months.)

Bond Cash Flows

Because most bonds pay interest semianually, the discussion of Bond Valuation presented here focuses on semiannual coupon bonds. However, the corresponding equations for annual coupon bonds are provided on the Bond Equations page.

Concepts

Tools and Problems

 

© 2002 - 2010 by Mark A. Lane, Ph.D.