Bond Pricing Formula

Formula to Calculate Bond Price

The formula for bond pricingBond Pricing The bond pricing formula calculates the present value of the probable future cash flows, which include coupon payments and the par value, which is the redemption amount at maturity. The yield to maturity (YTM) refers to the rate of interest used to discount future cash flows.read more is the calculation of the present value of the probable future cash flows, which comprises the coupon payments and the par value, which is the redemption amount on maturity. The rate of interest used to discount the future cash flows is known as the yield to maturity (YTM.)

Bond Price = ∑_i=1ⁿ C/(1+r)ⁿ + F/(1+r)ⁿ

Bond Price = C* (1-(1+r)^-n/r ) + F/(1+r)ⁿ

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For eg:
Source: Bond Pricing Formula (wallstreetmojo.com)

where C = Periodic coupon payment,

F = Face / Par value of bond,
r = Yield to maturity (YTM) and
n = No. of periods till maturity

On the other, the bond valuation formula for deep discount bonds or zero-coupon bondsZero-coupon Bonds In contrast to a typical coupon-bearing bond, a zero-coupon bond (also known as a Pure Discount Bond or Accrual Bond) is a bond that is issued at a discount to its par value and does not pay periodic interest. In other words, the annual implied interest payment is included into the face value of the bond, which is paid at maturity. As a result, this bond has only one return: the payment of the nominal value at maturity.read more can be computed simply by discounting the par value to the present value, which is mathematically represented as,

Zero-Coupon Bond Price = (as the name suggests, there are no coupon payments)

Formula to Calculate Bond Price

The bond pricing formula involves calculating the present value of the anticipated future cash flows, including coupon payments and the par value, or the amount redeemed when the bond matures. The interest rate discounting future cash flows is called the “yield to maturity (YTM).
Bonds are an essential component of the financial markets, making bond pricing particularly significant. Analysts and investors must thus comprehend how a bond’s many features interact to assess its underlying value.
Bond pricing is integral to bond investing since it helps determine if an investment suits a portfolio.

Bond Pricing Calculation (Step by Step)

The formula for Bond Pricing calculation by using the following steps:

Firstly, the face value or par value of the bond issuance is determined as per the company’s funding requirement. The par value is denoted by F.
Now, the coupon rate, which is analogous to the interest rate of the bond and the frequency of the coupon payment, is determined. The coupon payment during a period is calculated by multiplying the coupon rate and the par value and then dividing the result by the frequency of the coupon payments in a year. The coupon payment is denoted by C.

C = Coupon rate * F / No. of coupon payments in a year
The total number of periods till maturity is computed by multiplying the years till maturity and the frequency of the coupon payments in a year. The number of periods till maturity is denoted by n.

n = No. of years till maturity * No. of coupon payments in a year
The YTM is the discounting factor, which is determined based on the current market return from an investment with a similar risk profile. The YTM is denoted by r.
Now, the present value of the first, second, third coupon payment, and so on so forth, along with the present value of the par value to be redeemed after n periods, is derived as,
Finally, adding together the present value of all the coupon payments and the par value gives the bond price as below,

Practical Examples (with Excel Template)

You can download this Bond Pricing Formula Excel Template here – Bond Pricing Formula Excel Template

Example #1

Let us take an example of a bondExample Of A Bond Bonds refer to the debt instruments issued by governments or corporations to acquire investors’ funds for a certain period.read more with annual coupon payments. 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 15 years. 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,

Bond price = $83,878.62

Since the coupon rateCoupon Rate The coupon rate is the ROI (rate of interest) paid on the bond's face value by the bond's issuers. It determines the repayment amount made by GIS (guaranteed income security). Coupon Rate = Annualized Interest Payment / Par Value of Bond * 100%read more is lower than the YTM, the bond price is less than the face value, and as such, the bond is said to be traded at a discount.

Example #2

Let us take an example of a bond with semi-annual coupon payments. Let us assume a company ABC Ltd has issued a bond having the face value of $100,000 carrying a coupon rate of 8% to be paid semi-annually and maturing in 5 years. The prevailing market rate of interest is 7%.

Hence, the price of the bond calculation using the above formula as,

Bond price = $104,158.30

Since the coupon rate is higher than the YTM, the bond price is higher than the face value, and as such, the bond is said to be traded at a premium

Example #3

Let us take the example of a zero-coupon bond. Let us assume a company QPR Ltd has issued a zero-coupon bond with a face value of $100,000 and matures in 4 years. The prevailing market rate of interest is 10%.

Hence, the price of the bond calculation using the above formula as,

Bond price = $68,301.35 ~ $68,301

Use and Relevance

The concept of bond pricing is very important because bonds form an indispensable part of the capital markets. As such, investors and analysts must understand how a bond’s different factors behave to calculate its intrinsic value. Similar to stock valuation, the pricing of a bond helps understand whether it is a suitable investment for a portfolio and consequently forms an integral part of bond investing.

Bond Pricing Formula Video

Frequently Asked Questions (FAQs)

What is mid-swap in bond pricing?

The midway point between the purchase and sell prices (bid and offer prices) for currency or interest rate transactions is known as the mid-swap price.

What is a tick in bond pricing?

A tick is the smallest increase or decrease in a security’s price. The price variation of a security from one trade to the next can also be referred to as a tick. The minimum tick size for equities trading above $1 has been one cent since 2001, with the introduction of decimalization.

What is a bond pricing date?

The pricing date is when an issuance’s interest rates, yields, and prices are decided. Depending on the situation, the length of the price period might be anything from a few hours to many days.

Bond Pricing Formula

Formula to Calculate Bond Price

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