Bond Valuation

Master the art of determining fair value for fixed-income securities

Fixed Income SecuritiesInterest Rate RiskYield to Maturity

I. Fundamental Concepts

Core principles of bond valuation and fixed income securities

A. Core Principle

Bond valuation is the process of determining the fair value of a bond. Like any financial asset, the value of a bond is the present value of its expected future cash flows, which consist of periodic interest payments and the return of the principal amount at maturity.

Key Insight:

A bond's value equals the present value of all its future cash flows discounted at the required rate of return.

B. Key Terminology

Bond

A long-term debt instrument used by businesses and government to raise large sums of money

Par Value (Face Value)

The amount borrowed by the company and the amount owed to the bond holder on the maturity date (typically $1,000)

Coupon Interest Rate

The percentage of a bond's par value that will be paid annually, typically in two equal semiannual payments

Maturity Date

The time at which a bond becomes due and the principal must be repaid

C. Basic Bond Characteristics

• Most bonds pay interest semiannually at a stated coupon interest rate
• Bonds typically have an initial maturity of 10 to 30 years
• Most bonds have a par value of $1,000 that must be repaid at maturity
• Bond prices are typically quoted as a percentage of par value
• Bond values move inversely to market interest rates

D. Why Bond Valuation Matters

• Essential for making investment decisions in fixed income markets
• Helps investors determine if a bond is overvalued or undervalued
• Critical for understanding interest rate risk
• Required for portfolio management and asset allocation
• Foundation for understanding more complex fixed income derivatives