How to Compute a Bond Price
Investors generally use two types of price strategies for bond investment. Some bond investors buy quality bonds and keep them until they mature (buy and hold method). These investors don't concern themselves with bond price relative to market yield. Other investors trade on the open market, buying and selling bonds at the best possible price. Interest rates are a key factor affecting the price of bonds, so this type of investor understands that a bond price must be adjusted accordingly to actively trade in and out of the market.
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Instructions
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Find the original price you paid for the bond as well as the fixed interest rate at the time it was purchased. If a bond was purchased for $2,000 at a fixed rate of 5 percent for 10 years, then it would yield a 5 percent return on that price for the life of the bond.
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Multiply the original bond price by the annual fixed interest rate at the time of purchase. This will give you the fixed amount of interest the bond earns yearly or its annual interest amount. For instance if you purchased a bond for $2,000 at a fixed annual interest rate of 5 percent, then you would multiply 2,000 by .05 to get $100. This means the bond would pay you $100 each year for the number of years until the bond matures. At the time it matures, the bondholder would receive all annual interest earned on the bond plus the original $2,000.
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Divide the annual interest earned on the bond by the current interest rate to calculate the the current value of the bond. For example, if the bond earns $100 per year at 5 percent and the current interest rate is 7 percent, divide 100 by .07 to find the bond price. The entire formula is as follows: annual interest amount / current interest rate = bond price. In this example, $100 / 0.07 = $1,428.57. This is the price discounted to match the current market yield. It is lower because the bond was paying less at the time it was taken. In the case that the current interest rates are lower (say 4 percent), the calculation would be $100 / 0.04 = $2,500. From this example, it is evident the bondholder could charge a higher, or "premium," rate because the original bond was paying more.
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Tips & Warnings
If you decide to begin investing in bonds, there are brokers that specialize in certain types. They can give you suggestions as to various bond ratings, current yield and length of maturity to help you find the types of bonds that suit your needs best.
References
- Photo Credit savings bonds image by judwick from Fotolia.com
