Contents
1. Bond Pricing
2. Bond Pricing: Coupons
3. Bond Pricing: Principal/Par value
4. Bond Pricing: Yield to Maturity
5. Bond Pricing: Periods to Maturity
6. Bond Pricing: Main Characteristics
7. Bond Pricing: alternative “Soft” Characteristics
Bond Pricing
A bond rating is an empirical matter within the field of monetary instruments. The value of a bond depends on many characteristics inherent in each bond issued. These characteristics are:
• Coupon, or lack therefrom
• Principal/par worth
• Yield to maturity
• Periods to maturity
Alternatively, if the bond is worth and every however one among the characteristics is celebrated, the last missing characteristic is solved.
Bond Pricing: Coupons
A bond might or might not accompany hooked-up coupons. A coupon is declared as a nominal share of the value (principal amount) of the bond. Every coupon is the redeemable per amount for that share. As an example, the tenth coupon on a $1000 par bond is redeemable for every amount.
A bond may additionally accompany no coupon. In this case, the bond is understood as a zero-coupon bond. Zero-coupon bonds are generally priced below bonds with coupons.
Bond Pricing: Principal/Par value
Each bond should accompany a value that’s repaid at maturity. While not the principal worth, a bond would haven’t any use. The principal worth is to be repaid to the loaner (the bond purchaser) by the receiver (the bond issuer). A zero-coupon bond pays no coupons however can guarantee the principal at maturity. Purchasers of zero-coupon bonds earn interest by the bond being oversubscribed at a reduction in its value.
A coupon-bearing bond pays coupons for every amount and a coupon and principal at maturity. the value of a bond includes these payments discounted at the yield to maturity.
Bond Pricing: Yield to Maturity
Bonds are priced to yield a particular comeback to investors. A bond that sells at a premium (where worth is on top of par value) can have a yield to maturity that’s below the coupon rate. or else, the relation of the link between yield to maturity and worth is also reversed. A bond can be oversubscribed at a better worth if the supposed yield (market interest rate) is below the coupon rate. this is often a result of the investor can receive coupon payments that are beyond the market charge per unit, and will, therefore, pay a premium for the distinction.
Bond Pricing: Periods to Maturity
Bonds can have a variety of periods to maturity. These are generally annual periods, however, may additionally be semi-annual or quarterly. The number of periods can equal the number of coupon payments.
Bond Pricing: Main Characteristics
Ceteris paribus, all else control equal:
- A bond with a better coupon rate is priced higher
- A bond with a better value is priced higher
- A bond with a better variety of periods to maturity is priced higher
- A bond with a better yield to maturity or market rates is priced lower
An easier thanks to keep in mind is often that bonds are priced higher for all characteristics, aside from yield to maturity. A better yield to maturity ends up in a lower bond rating.
Bond Pricing: alternative “Soft” Characteristics
The empirical characteristics printed on top affect bond problems, particularly within the primary market. There is an alternative, however, bond characteristics that may affect the bond rating, particularly within the secondary markets. These are:
- Creditworthiness of supplying firm
- Liquidity of bond trade
- Time to next payment
Firm trustiness
Bonds are rated supported by the trustiness of the supplying firm. These ratings vary from AAA to D. Bonds rated beyond A are generally called investment-grade bonds, whereas something lower is conversationally called junk bonds.
Junk bonds would require a better yield to maturity to catch up on their higher credit risk. Owing to this, junk bonds trade at a cheaper price than investment-grade bonds.
Bond Liquidity
Bonds that are a lot wide-listed are a lot of valuable than bonds that are sparsely listed. Intuitively, capitalists are cautious of buying a bond that may be tougher to sell subsequently. This drives the costs of illiquid bonds down.
Time to Payment
Finally, time to consequent coupon payment affects the “actual” worth of a bond. This is often a lot of complicated bond rating theory, called ‘dirty’ rating. A dirty rating takes into consideration the interest that accrues between coupon payments. Because the payments meet up, an investor should wait less time before receiving his next payment. This drives costs steady higher before it drops once more right when coupon payment.
