Question

How does a bond’s par value differ from the market value? Explain the difference between a bond’s coupon rate, current yield and required rate of return. After answering the question, provide a detailed example of a current bond (price, coupon, YTM, time, etc) and using the data you have created, provide a calculation for one of the variables (for example, what is the present value, or what are the coupon payments). You may choose which variable to calculate.

Answer 1

The value of the bond at the date of maturity of the bond is known as the par value of the bond. Before the date of maturity of the bond, the value of the bond changes, moves up or down depending upon the changes in the yield of the bond. The market value is what is the mist important for the investors.

The coupon rate of bond is the return actually earned by the investors, the current yield of a bond is the return earned by the bind, on the basis of the amount actually invested by the investor on the bond.

Current yield = interest earned by the investor/ current price of the bond

The required rate of return is the return that the issuer must offer in order to attract investors to invest in the bond. It is set by the market and finally determined by what the investors and the issuer agree upon.

For example, suppose a bond with a par value of $1000, has a coupon rate of 4% compounded annually , the YTM of the bond is 6%. The time period of the bond till maturity  is 8 years, Find the present value of the bond.

FV = $1000

PMT = $40

N = 8 YEARS

YTM = 6%

The present value of bond is :($875.8041)

= $875.80