INVESTING IN BONDS

TELECOM ITALIA CAP has a face value of $ 1000 and a coupon rate of 6%. The bond has a life of 20 years to maturity, pay annual coupons and the YTM is 5 % what will the bond sell for?

Value of the bond       = PV of annuity + PV of single cash flow

PV of annuity             = interest*PVIFA5%, 20 years

= (0.06*1000)*12.462 =$747.72

PV of single cash flow            = face value*PVIF5%, 20years

=1000*0.3769= $376.90

Value of the bond= $747.72+376.9= $1124.62

The bond is selling at a premium because its value is higher than the face value by $124.62. A bond that offers a higher rate of coupon or interest than the yield to maturity is said to be trading at a premium. This is because it promises higher returns to the investors. Generally, the yield to maturity and the coupon rate determines the bond’s performance in the market between its issuance and maturity because the investors demand a higher yield (Wessels, et al 2013).

There are several other factors that affect or may influence the value of a bond namely inflation and credit ratings. A rise in inflation results in a decrease in the value of the bond because increasing inflation erodes the purchasing power of what the investors will earn on their investment (Wessels, et al 2013). Time to maturity also may influence the value of the bonds, for instance, decreasing the time to maturity decreases the market value of the bonds. A higher credit rating makes the price of the bond to go up because it implies that the issuer is able to meet its payment obligations (Wessels, et al 2013).

 

 

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