Illustration
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Discount bond (5 yr. bond with 10% coupon) (expected rate yield at 12%)
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Premium bond (expected yield at 7.8%)
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|
5
|
92.6
|
109.0
|
|
4
|
93.8
|
107.4
|
|
3
|
95.1
|
105.8
|
|
2
|
96.5
|
104.0
|
|
1
|
98.2
|
102.0
|
|
0
|
100.0
|
100.0
|
Reasons for price changes of a bond:
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Change in the yield requirement of the issuer due to changes in the quality of credit of the issuer.
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Change in the price as the bond approaches maturity in case of premium or discount bond.
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Change in the price because of change in the yields of comparable bonds/securities.
While computing the bond pricing, the following assumptions are made:
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Cash flows are known.
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Coupon payment annually/semi-annually is made at exact period.
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Required yield can be estimated.
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One rate is used to discount all cash flows, i.e., with required yield rate.
The following cash factors are to be considered:
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For callable bonds, cash flows cannot be certain. The investment decisions of the issuer depend on interest rate movements and other factors.
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It is not possible to determine the appropriate yields and it need not be a single rate for all the future cash flows.