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Bond valuation is the process by which an investor arrives at an estimate of the theoretical fair value, or intrinsic worth, 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.
The standard broker valuation formula (incorporated in the Price function in Excel or any financial calculator, such as the HP10bII) confirms this; the main term calculates the actual (dirty price), which is the total cash exchanged, less a second term which represents the amount of accrued interest.
The accounting equation plays a significant role as the foundation of the double-entry bookkeeping system. The primary aim of the double-entry system is to keep track of debits and credits and ensure that the sum of these always matches up to the company assets, a calculation carried out by the accounting equation. It is based on the idea that ...
The need for day count conventions is a direct consequence of interest-earning investments. Different conventions were developed to address often conflicting requirements, including ease of calculation, constancy of time period (day, month, or year) and the needs of the accounting department.
In finance, accrued interest is the interest on a bond or loan that has accumulated since the principal investment, or since the previous coupon payment if there has been one already. For a type of obligation such as a bond, interest is calculated and paid at set intervals (for instance annually or semi-annually). However ownership of bonds ...
Even though the yield-to-maturity for the remaining life of the bond is just 7%, and the yield-to-maturity bargained for when the bond was purchased was only 10%, the annualized return earned over the first 10 years is 16.25%. This can be found by evaluating (1+i) from the equation (1+i) 10 = (25.84/5.73), giving 0.1625.
Analytic Example: Given: 0.5-year spot rate, Z1 = 4%, and 1-year spot rate, Z2 = 4.3% (we can get these rates from T-Bills which are zero-coupon); and the par rate on a 1.5-year semi-annual coupon bond, R3 = 4.5%. We then use these rates to calculate the 1.5 year spot rate. We solve the 1.5 year spot rate, Z3, by the formula below:
These equations are frequently combined for particular uses. For example, bonds can be readily priced using these equations. A typical coupon bond is composed of two types of payments: a stream of coupon payments similar to an annuity, and a lump-sum return of capital at the end of the bond's maturity—that is, a future payment. The two ...