A bond's selling price is the sum of two separate values. The first is the bond's principal, or face value. When the bond matures, its issuer must pay this sum to the investor. The second is the bond's added value from interest, which relates to the regular dividends the bond pays at its coupon rate, which is its interest rate. The bond's selling price combines these values because a new buyer expects to receive dividends, to reinvest them, to compound the returns and to finally receive the bond's par value at maturity.
1. Divide the bond's term length by the length of each period that pays dividends. For example, assume that a 10-year bond pays dividends each year. Divide 10 by 1 to get 10 dividends.
2. Add 1 to the bond's coupon. For example, if the bond pays a coupon of 5.5 percent, or 0.055, add 1 to 0.055 to get 1.055.
3. Raise this annual multiplier by the number of pay periods from Step 1. Raising 1.055 to the power of 10 gives 1.7081.
4. Subtract 1 from this multiplier. Continuing the example, 1.7081 minus 1 gives 0.7081.
5. Multiply this answer by the bond's principal. For example, if the bond has a principal of $7,250, multiply 0.7081 by $7,250 to get $5,133.73. This is the total value of the bond's reinvested dividends.
6. Add this value to the bond's principal. $5,133.73 plus $7,250 gives $12,383.72. This is the bond's selling price.
- The Strategic Bond Investor: Strategies and Tools...; Anthony Crescenzi and Mohamed El-Erian; 2010
- All About Bonds...; Esme Faerber; 2008
- Bonds: The Unbeaten Path to Secure Investment Growth; Hildy Richelson and Stan Richelson; 2011
- Mt. Holyoke College: The Bond Market
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