How To Arrive At A Price For Bond

By Jaclyn Hurley


In most cases, the valuation of the securities being traded within a specified market is determined by interplay of factors. The demand and supply of such commodities often determines the much that the traders are likely to part with in order to acquire such securities. The higher the demand of a commodity within the markets, the higher the face value. A price for bond has to take into consideration the demand the supply factors too.

The valuation of the bonds being traded in the market of other securities is done after the cash flows have been taken into consideration. In practice, the face value of the bonds in trading is often the present value of the future cash flows. All the relevant costs have to be deducted from the value of the cash flows. This is done using an appropriate discount factor.

There are very many classes of bonds that are traded in the different markets. Some of the bonds have the options of conversion after maturity. This means that the owners can convert the bonds into other forms of securities after the date of maturity. The embedded options give the owners a chance to change them into a number of equity options depending on the price.

Gathering of various pieces of information such as the yield rates and the discount factors can be very hard. Where the information about the yield rates and the discount rates is not available, a relative approach is used. The bonds in question are priced relative to a benchmark. A benchmark is often a security that bears the almost the same amount of risks and returns. These could be government securities or corporate assets. Special adjustments ought to be done to reflect the risk in specific industries.

Traders have an option of segregating the different cash flows expected from their investments. This means that they treat them as special packages. In some markets, the cash flows are treated as zero-rated coupons. Each coupon has a different rate of return. The costs may be netted off against the expected returns. The use of separate rates of returns means that the traders have an option of bundling the cash flows.

There are a couple of risks that affects the rates of investment and the return from bonds. The risks are mainly categorized into finance and business related. The finance risks are often associated with the level of risks in each security. Business risks are associated with specific lines of businesses.

Modeling is often done in scenarios where there is a need to put the specific risks into consideration. Interest rates derivative is used in the building a scenario. The model recognizes that most of the interest rates and rates of returns are uncertain. Specific equations are used for estimating the likely rates of returns. This is done by plugging the current rates into the equation so as to estimate the future rates.

Accuracy in estimation of prices is very important. This reduces the chances of caring the errors forward. It also ensures that the traders are feed with the right information. This is good for the market as the investment decisions are made using accurate data reducing the losses likely to be made.




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