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Bond Valuation (Calculations for CFA® and FRM® Exams)

AnalystPrep's Concept Capsules for CFA® and FRM® Exams This series of video lessons is intended to review the main calculations required in your CFA and FRM exams. For Level I Video Lessons, Study Notes, Question Bank, CBT Mock Exams & More: https://analystprep.com/shop/cfa-leve... For FRM (Part I & Part II) Video Lessons, Study Notes, Question Bank, CBT Mock Exams & More: https://analystprep.com/shop/unlimite... AnalystPrep is an Official GARP-Approved Exam Preparation Provider Bond Valuation Bond valuation is an application of discounted cash flow analysis. The general approach to bond valuation is to utilize a series of spot rates to reflect the timing of future cash flows. Bond Pricing with a Market Discount Rate For option-free or fixed rate bonds, future cash flows are a series of coupon interest payments and a repayment of principal at maturity. The price of the bond at issuance is the present value of future cash flows discounted at the market discount rate. The market discount rate, also called required yield or required rate of return, is the rate of return required by investors based on the risk of the investment. European bonds make annual payments whereas Asian and North American bonds generally make semiannual payments. For semiannual payments, semiannual coupon payments are discounted by one half of the market discount rate (Mdr). Yield-to-Maturity If the market price of a bond is known, the discounted cash flow equation can be used to calculate its yield-to-maturity, or in other words, the internal rate of return of the cash flows. The yield-to-maturity is also the implied market discount rate. Price versus Market Discount Rate (Yield-to-maturity) The price of a fixed-rate bond will fluctuate whenever the market discount rate changes. This relationship could be summarized as follows: ● When the market discount rate increases, the bond's price decreases (inverse effect). ● When the market discount rate decreases, the bond's price increases (inverse effect). However, the percentage price change is greater in absolute value when the market discount rate goes down than when it is up due to the convexity effect.