Explain methods for valuation of bonds and the term structure of interest rates. Please
provide an example in your response. 750 words
Methods of Valuation of Bonds and Term Structure of Interest Rates
Valuation of Bonds
Bond is a debt instrument, which is used by the companies, government, municipalities to raise the capital. Consequently, bond issuer is obligated to pay a certain sum of money to an investor with interest after a period of time. A bond is issued to an investor for more than one year.
Bond is a debt instrument that identifies the value of the bond. It evaluates the present value of a bond that enables to calculate the future interest amount.
Bond value = Interest1/(1+r)^1 + Interest2/(1+r)^2 + ...........+ ((〖Interest〗_n+Naturity value))/(1+r)^n (Ammann, 2013)
For example, face value of the bond is $1,500 and maturity value is $1,500. Therefore, bond coupon rate is 8% payable semi-annually and yield maturity is 8%. The maturity period of the bond is 3 years. Find the value of the bond?
Interest 1 = semiannual period is $60 (annually $120)
3 (years) ×2 (semiannually)
Yield maturity = 8%, hence, semi-annual return =8/2 = 4% or 0.04
= $60/(1+0.04)^1 + $60/(1+0+04)^2 + ...........+ ($60+$1500)/(1+0.04)^6
Bond price = $1527
There are four methods of bonds valuation that are explained below:
Present Value Approach
Present value method calculates the value of the bond. It identifies the current value of the bond for the future cash flows. Formula of calculation of bond is:
P= C ...
This post has discussed the different methods of valuation of bonds and also, it has analyzed the term structure of interest rates.