Fixed Rate Bond Valuation
A bond is a debt instrument in which an investor loans money to the issuer for a defined period of time and receives coupons paid by the issuer at fixed interest rate. The bond principal will be returned at maturity date. Bonds are usually issued by companies, municipalities, states/provinces and countries to finance a variety of projects and activities. This presentation gives an overview of fixed rate bonds and also elaborates two valuation models at http://www.finpricing.com/lib/FiBond.html
Fixed rate bonds generally pay higher coupons than interest rates. An investor who wants to earn a guaranteed interest rate for a specified term can choose fixed rate bonds. The benefit of a fixed rate bond is that investors know for certain how much interest rate they will earn and for how long. Due to the fixed coupon, the market value of a fixed rate bond is susceptible to fluctuation in interest rate and therefore has a significant interest rate risk.
There are two types of bond valuation models in the market: yield-to-maturity model and credit spread model.
A fixed rate bond is a debt instrument in which an investor loans money to the issuer for a defined period of time and receives coupons paid by the issuer at fixed interest rate. The bond principal will be returned at maturity date. Bonds are usually issued by companies, municipalities, states/provinces and countries to finance a variety of projects and activities. This presentation gives an overview of fixed rate bonds and also discusses two valuation models.
There are two types of bond valuation models in the market: yield-to-maturity model and credit spread model.
The present value of a bond under the yield-to-maturity model is given by V(t)=∑_(i=1)^n〖cP/(1+y)^i +P/(1+y)^n 〗 where
t – the valuation date P – the principal amount or face value y – the yield to maturity c – the coupon rate i – the ith cash flow or coupon from 1 to n
Valuation: Credit Spread Approach
The present value of a fixed rate bond under the credit spread model can be expressed as V(t)=∑_(i=1)^n〖cPe^(-(r_i+s) T_i )+Pe^(-(r^n+s) T_n ) 〗 where
t – the valuation date i – the ith cash flow from 1 to n
r_i – the continuous compounded interest rate for period (t,T_i) T_i – the coupon payment date of the ith cash flow s – the credit spread P – the principal amount or face value c – the coupon rate
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