Bond valuation

December 29, 2020 By Swapnil Suryawanshi

Bond valuation is the determination of the fair price of a bond. As with any security or capital investment, the theoretical fair value of a bond is the present value of the stream of cash flows it is expected to generate. Hence, the value of a bond is obtained by discounting the bond’s expected cash flows to the present using an appropriate discount rate.

\begin{align}
P &= \begin{matrix}
     \left(\frac{C}{1+i}+\frac{C}{(1+i)^2}+ ... +\frac{C}{(1+i)^N}\right) + \frac{M}{(1+i)^N} 
     \end{matrix}\\
  &= \begin{matrix}
     \left(\sum_{n=1}^N\frac{C}{(1+i)^n}\right) + \frac{M}{(1+i)^N} 
     \end{matrix}\\
  &= \begin{matrix}
     C\left(\frac{1-(1+i)^{-N}}{i}\right)+M(1+i)^{-N}
     \end{matrix}
\end{align}

Bond valuation is a way to determine the theoretical fair value (or par value) of a particular bond. It involves calculating the present value of a bond’s expected future coupon payments, or cash flow, and the bond’s value upon maturity, or face value.6 days ago

To actually determine the bond price, the analyst must choose the specific short rate model to be employed. The approaches commonly used are:

CFA Level 1 Exam: Get to Know 4 Methods of Bond Valuation | SOLEADEA

Note that depending on the model selected, a closed-form (“Black like”) solution may not be available, and a lattice- or simulation-based implementation of the model in question is then employed. See also Bond option § Valuation.