Page 200 - A Canuck's Guide to Financial Literacy 2020

200

Pricing Bonds

When it comes to pricing bonds, let’s first start with the basics. All bonds have an issue
date, a maturity date and a stated face value or par value. Bonds are priced in 100s as a
percentage of the par value. A bond with the face value of $1,000 may have a bond price of
100. For example, a bond trading at 97, means it’s trading at 97% of its par value or $970.

▪ The coupon rate of a bond is the stated interest rate that is used to calculate the
periodic interest paid on each coupon date. Keep in mind that bonds pay interest
semi-annually!

Upon maturity, the investor will receive their final interest payment plus the original
principal.

With basic bonds, the issue date, maturity date and the coupon rate never change.
The only features that change are the bond’s price and yield.

Price/Yield Relationship

▪ The yield of a bond is related to the current market interest rates. The price of the
bond is determined by discounting the future coupon payments and the par value at
the current market interest rates.

Keep in mind that interest rates and bond prices have an inverse relationship.

▪ When current market interest rates RISE, bond prices FALL
▪ When current market interest rates FALL, bond prices RISE

Using the above examples, try changing the interest rate to 5% and then 10%. You’ll notice
the inverse relationship mentioned above. As interest rates rise, bond prices fall and vice
versa.