Read the introductory content and then have a go at the Multi Choice Quiz on bond calculations.
Bonds are interest-bearing securities that firms and governments can issue to raise capital. Investors will buy a bond at its face value (nominal value) and will be repaid this amount at the bond’s maturity date.
For the duration of the bond’s life before its maturity date, the bondholder will be paid interest - known as a coupon. This is typically paid once a year and gives a return that makes holding the bond worthwhile.
Bonds can be traded on secondary markets once they have been issued. Each bond will have a market price when it is bought and sold.
Whilst the coupon payment is fixed throughout the lifetime of the bond, you can calculate a bond’s yield to work out its effective interest rate (annual return) based on the market price. The less someone pays for a given bond, the higher the yield will be. This is because the fixed coupon amount will be a higher proportion of the price paid for the bond.
The formula for calculating a bond’s yield is:
Yield (%) = (Coupon/Market Price) x 100
Calculate the yield on a bond with a current market price of £100 and a coupon of £7.
Yield (%) = (£7/£100) x 100 = 7%
Now calculate the yield if the market price falls to £70.
Yield (%) = (£7/£70) x 100 = 10%
As this example shows, there is an inverse relationship between bond prices and yields – as bond prices go down, yields go up (and vice versa)!
The yield formula can be rearranged to find out the value of the coupon or market price of the bond (depending on the information that you are given):
Market price = (Coupon/Yield) x 100
Coupon = (Market Price x Yield)/100
Have a go at applying your knowledge to this multi choice quiz on bond calculations. Good luck!
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