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valuation of BOND

what is the logic of the valuation bond formula , sir please explain the logic behind the formula why there are two interest rate in bond valuation

nisam M

CA Foundation

10K+

26-Jan-21 00:17

20

One interest rate is the coupon ie the interest that is received by you. Second interest rate is teh discount rate Think of bond like an FD Say you invested 100 in FD for 1 year when interest rates were 10%. on that date market rate was also 10% and hence your FD rate was also 10%. Interest is paid at end of the year so after one year you will get 10+ 100 = 110 and discount this by market rate of 10% i.e ( 1+ 10%) = 1.1 so 110 /1.1 = 100. So value of FD is 100 Say on next day morning market interest rate for 1 year came down to 5% then present value of your cash inflow is 110 ( because your interest rate on FD is fixed for 1 year irrespective of what market rate is) divided by ( 1+5%) i.e 110 /1.05 = 104.7. So when market rates go down bond prices increase and when market rates go up bond prices decrease

Sriram Somayajula

28-Jan-21 21:21

Thank u sir

nisam M

CA Foundation

10K+

28-Jan-21 21:29