The price of a bond remains unchanged and unaffected when it is not called for redemption before maturity. Under such circumstances, interest rates, changing prices, and yields do not affect the investor but when they are bought or sold before maturity the price investors are actually willing to pay for an outstanding bond may fluctuate along with the bond's yield, or the expected return on the bond.
Factors that affect the price of bonds
When new bond issues are advertised or notified in the media, the bond prices are provided in terms of percentage of face value. For instance a corporate bond with a face value of USD 10,000 may go through price changes at three points over a period of time that results in market price variations of 96, 97, and 101 percent of the value respectively.
Therefore:
It has been observed that newly issued bonds normally offer higher returns when existing interest rates go up. Under these circumstances, outstanding bonds with lower coupon rates find it difficult to remain competitive. This is because investors would not be attracted to any outstanding bond that offers a lower coupon rate unless they can get it at a lower price. Thus when interest rates go up the price of outstanding bonds go down. On the other hand, when interest rates fall, the coupon rate of outstanding bonds appeal more to investors, pushing up the price. Therefore it is evident that price and interest rates normally move in opposite directions.
For instance:
A corporate bond with a face value of USD 10,000 and a coupon rate of 4 % goes through an interest rate variation of 4 %, 6 %, and 2 %, respectively at three different points of time.
Therefore:
Factors that affect the price of bonds
When new bond issues are advertised or notified in the media, the bond prices are provided in terms of percentage of face value. For instance a corporate bond with a face value of USD 10,000 may go through price changes at three points over a period of time that results in market price variations of 96, 97, and 101 percent of the value respectively.
Therefore:
- When the price variation is at 96 % of the face value the market price of the bond will be USD 9,600
- When the price variation is at 97 % of the face value the market price of the bond will be USD 9,700
- When the price variation is at 101 % of the face value the market price of the bond will be USD 10,100
It has been observed that newly issued bonds normally offer higher returns when existing interest rates go up. Under these circumstances, outstanding bonds with lower coupon rates find it difficult to remain competitive. This is because investors would not be attracted to any outstanding bond that offers a lower coupon rate unless they can get it at a lower price. Thus when interest rates go up the price of outstanding bonds go down. On the other hand, when interest rates fall, the coupon rate of outstanding bonds appeal more to investors, pushing up the price. Therefore it is evident that price and interest rates normally move in opposite directions.
A corporate bond with a face value of USD 10,000 and a coupon rate of 4 % goes through an interest rate variation of 4 %, 6 %, and 2 %, respectively at three different points of time.
Therefore:
- When the prevailing interest rate is the same as the bond's coupon rate, the price of the bond is unchanged, and investors would pay USD 10,000 for the bond
- When the prevailing interest rate goes up to 6 % investors would purchase the bond at a discount as the price drops to 95 %, which means they are willing to pay USD 19,000 for the bond.
- When the prevailing interest rate drops to 2 % investors would pay extra for the bond as it pays higher interest with the price going up to 106 %, which means they are willing to pay USD 21,200 for the bond.
