So what is the bond's current market price if the yield to maturity is 11% ? While it is possible to discount each cash flow back to the present and sum those present values to find the bond's value, this is a very time-consuming method. Instead, you may use a financial calculator to solve the problem: In this case, the bond's coupon rate (10%) is less than the current market interest rate (11%), so this bond is a discount bond. Suppose a bond has a par value of $1,000. If the bond's coupon rate is 5% and the current market interest rate is 10%, the bond's current market price is its par value, so this bond is called a bond. Step 2: Learn: Bond Valuation Although the amount of interest paid on a bond is fixed, bond prices fluctuate with the market interest rate. Comparing the price of a bond relative to its par value is important because it tells you whether the bond is a par bond, discount bond, or premium bond. Watch the following video for an example, then answer the questions that follow. Ch 07-Video Lesson - Bonds and Their Valuation Bond's Value =t=1N(1+rd)tINT+(1+rd)NM Where: rd : the market rate of the interest on the bond. This is not the coupon interest rate, however rd may be equal to the coupon rate at times. N : the number of years before the bond matures, which is 13 years in this case INT: dollars of interest paid each year. This is equal to the coupon rate times the par value, which is you calculated earlier as $100. M : the par, or maturity, value of the bond, or $1,000 in this case Although the coupon rate remains fixed after the bond is issue, interest rates in the market move up and down. Whenever the going rate of interest rises above the coupon rate, a fixed-rate bond's price will fall below its par value, so this bond is called a discount bond. On the other hand, if the going rate of interest falls below the coupon rate, a fixed-rate bond's price will rise above its par value, so this bond is called a premium bond. A bond is a long-term contract under which a borrower agrees to make payments of interest and principal on specific dates to the holders of the bond. For example, suppose that Sunny Snacks borrowed $120 million by issuing $120 million of bonds. Sunny Snacks' bonds require the company to pay a fixed number of dollars of interest each year. This payment is known as the coupon payment, and it is set at the time the bond is issued and remains in force during the bond's life. When this annual coupon payment is divided by the par value, the result is the coupon interest rate. For example, Suppose Sunny Snack's bonds have a $1,000 par value, and the coupon interest rate is 10%. You can calculate the annual coupon payment in the following way: CouponInterestRateAnnualCouponRate=PurValueAnnualCouponRate=CouponInterestRateParValue=0.1$1,000=$100 This $100 is the annual income that an investor receives when they invest in the bond. So what is the bond's current market price when there are only 13 years left until the bond matures? The value of any financial asset is the present value of the cash flows the asset is expected to produce. The cash flows for a standard coupon bearing bond, like those of Sunny Snacks, consist of interest payments during the bond's life plus the amount borrowed (generally the par value) when the bond matures. For a bond with a fixed coupon, like Sunny's, here is the situation: Now it's time for you to practice what you've learned. Clancy is deciding which two bonds he wants to invest in. Bond A has 23 years remaining to maturity, and the coupon interest rate is 11% per year. Bond B has 22 years to maturity, and the coupon interest rate is 6% per year. Both bonds have a $1,000 par value and the yield to maturity is 10%. Complete by the following table by using a financial calculator to determine the market price for each bond and whether the bond is a premium, discount, or par bond. Next, enter the number of years before the bond matures into the " N "cell of the following financial calculator table. Remember that the going rate of interest is what determines the market price of a bond. Therefore, this is the value that you would need to enter into your financial calculator. Enter the market interest rate into the "I/Y" cell of the following financial calculator table. Using a financial calculator, compute the present value of the cash flows this asset is expected to produce. Enter this value into the final row of the following table. Note: Make sure your calculator is set to END mode. The absolute value of the present value your calculator computed is the market price of the bond. Because the market price is the par value, your friend purchased a bond