© 2000 John Petroff
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© 2000 John Petroff |
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We start with bonds because determining their value is an immediate extension of the general formula. The coupon states precisely how much is received each year and the indenture specifies the exact dates when coupon and principal will be paid. There is still room for astute trading strategies which will be outlined in Section D of next chapter. For most bonds, calculation of bond value is a straightforward application of time value of money, as already illustrated in examples in Section C of the previous chapter. Bond value BV, i.e. present value of the sum of expected future benefits (i.e. coupon and principal), can be restated formally as
BV = C (1+i)-1 + … + C (1+i)-n + P (1+i)-n
Since for most bonds all the stated elements are known, all that remains to be done, is selecting a discount rate i. As shown below, this selection is also rather clear cut for many large corporate bonds.
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