Time Value of Money
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Future Value of an Uneven Cash flow
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Disclaimer
Bond Valuation
| Bond | When a company (or government) borrows money from the public or banks (bondholders) and agrees to pay it back later |
| Par Value | The amount of money that the company borrows. Usually it is $1,000. |
| Coupon Payments | This is like interest. The company makes regular payments to the bondholders, like every 6 months or every year. |
| Indenture | The legal stuff. A written agreement between the company and the bond holder. They talk about how much the coupon payments will be, and when the money (par value) will be paid back to the bondholder. |
| Maturity Date | Date when the company pays the par value back to the bondholder. |
| Market Interest Rate | This changes everyday. |
The thing about bonds is that the interest rate
(coupon payments) is fixed. It doesn't change. And bonds
last a long time. Like 10 years or whatever. So in the
meantime, the market interest rate (the interest rates in
general) go up and down. OK, well, if the coupon payments
are for 10% and then the market interest rates fall from
10% to 8%, then that bond at 10% is valuable, right. It
is paying 10% while the overall interest rate is only 8%.
Exactly how much is it worth? You mean 'what is the
present value of a bond?'
| The Present Value of a Bond | = | The Present Value of the Coupon Payments (an annuity) | + | The Present Value of the Par Value (time value of money) |
Example
- Par Value = $ 1,000
- Maturity Date is in 5 years
- Annual Coupon Payments of $100, which is 10%
- Market Interest rate of 8%
The Present Value of the Coupon Payments (an annuity) = $399.27
The Present Value of the Par Value (time value of money) =$680.58
The Present Value of a Bond = $ 399.27 + $ 680.58 = $1,079.86
About the author
 | Mark McCrackenAuthor: Mark McCracken is a corporate trainer and author living in Higashi Osaka, Japan. He is the author of thousands of online articles as well as the Business English textbook, "25 Business Skills in English".
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