How to Calculate a Bond Price
Bonds are issued by corporations and governments to borrow money for various purposes. What makes bonds different from other forms of borrowing is that bonds are traded in much the same way stocks are. Consequently, the bond’s price is usually different from its face value. For those new to investing in bonds, this can be confusing.
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Instructions
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Learn about bonds and how they work. Each bond has a face value and a coupon rate. The face value (typically $1,000 for corporate bonds) is the amount the issuer must pay whomever owns the bond when it matures. The coupon rate is a fixed annual sum paid by the issuer to the bond holder, most often in semiannual payments. A bond’s actual price will almost always be higher (selling at a premium) or lower (at a discount) than the face value. The yield of the bond (equivalent to interest rate) depends on both the coupon rate and the price (see Step 5).
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Convert bond quotes into the actual price of the bond. You can find daily bond price quotes in the newspaper, at online bond market sites or in financial publications like the "Wall Street Journal." Normally, the listing is a number that represents the price as a percentage of the face value. For example, if the quote is 87.5, the bond is selling for 87.5% of its face value. For a $1,000 corporate bond, the price would be $875.
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3
Keep up with interest rates. Bond investors look for bond yields that are at or above prevailing interest rates. This is the most important factor in determining the price of a bond. If interest rates rise, buyers will not be willing to pay as much for a bond and the price tends to fall (and the yield will rise since buyers get the same coupon rate with a smaller investment). When interest rates fall, the reverse happens and bond prices rise.
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4
Know the other factors that affect bond prices. Short-term bonds (a year maturity or less) are less risky than long-term bonds that often have 30-year maturities. This is because there’s more uncertainty about the distant future. A more important factor is the creditworthiness of the company or government issuing the bond. Bonds are rated by services such as Moody’s (see the link at the end of this article) with AAA bonds being the lowest risk. Prices of bonds that carry more risk tend to be lower than AAA “blue chip” bonds.
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5
Know how to calculate bond yield. Because the coupon rate is a fixed amount you find the yield by dividing the coupon rate by the price actually paid for the bond and expressing the result as a percentage. A bond with a coupon rate of $1,000 and a price of $875 then has a yield of 11.4%. In practice, the easiest way to calculate bond yields is to use bond yield calculator software. A number of bond yeld calculators are available online. There is a link at the end of this article to the Morningstar Bond Yield Calculator.
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