What is a Bond? - Finance - How to calculate the value of a bond. www.subjectmoney.com

Bonds are a form of debt issued by corporations or governments that usually take the form of interest only loans. Bonds consist of a coupon rate which is the interest payments, a face value (par value) which is the amount to be paid back to the lender at the end of the loan. The end of the loan is determined by time to maturity. Maturity is number of periods until the borrower must pay back the lender. The coupon payment divided by the face value of the bond is the coupon rate. For example a bond with a coupon payment of $80 and a face value of $1000 would have a coupon rate of $80/$1000 = 8%. Once bonds are purchased, the coupon rate remains the same and does not fluctuate with the interest rates demanded by the market. If a bond's coupon rate is lower than the interest rate demanded by the market then the bond will sell for less than it's par value, at a discount. If the rate of a bond is higher than the rate demanded by the market then it will sell at a premium. There is a way to value bonds but we need to know the yield to maturity (YTM). The yield to maturity is the interest rates that are demanded by the market for an asset of equal risk.
[Par value/(1+i)^n] + (coupon) x [1-(1/(1+i)^n)/i] = present value of bond

i = rate demanded by the market for an investment of equal risk.
n = number of periods left until the bond matures.
Example
Jerry wants to purchase a bond. The coupon of this bond is $80, the par value is $1000, maturity is 10 years and the YTM is 10%. What should he pay for this bond?

[$1000/(1.10)^i] + $80 x [(1-(1/1.10^10)/.10] = $877.11 is what Jerry should pay.

The reason why the value of bonds fluctuate with interest rates is to compensate for the lost interest. If there was a bond with an 8% coupon selling in the open market and the rate demanded by the market was 10%, why would you purchase an 8% bond when you could earn 10% elsewhere? In order for the 8% bond to get the attention of buyers it must lower it's price to compensate for the less than ideal interest payments that come with it.

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