Syllabus E. Treasury And Advanced Risk Management Techniques E3. The use of financial derivatives to hedge against interest rate risk

Market Value of Bonds 11 / 13

Market Value of Bonds

Have a think (or even better) a look at when we calculated the cost of debt for Irredeemable debts (bonds)

You will see that we took the capital and interest and discounted it (at a guessed rate) then compared it to the MV of the bond..and so on

This is because you calculate the MV of a loan or a bond by taking its Capital and Interest and discounting it down by the cost of debt

Therefore the MV of Bonds is affected by:

  1. Amount of interest payment

    The market value of a traded bond will increase as the interest paid on the bond increases, since the reward offered for owning the bond becomes more attractive.

  2. Frequency of interest payments

    If interest payments are more frequent, say every six months rather than every year, then the present value of the interest payments increases and hence so does the market value.

  3. Redemption value

    If a higher value than par is offered on redemption, the reward offered for owning the bond increases and hence so does the market value.

  4. Period to redemption

    The market value of traded bonds is affected by the period to redemption, either because the capital payment becomes more distant in time or because the number of interest payments increases.

  5. Cost of debt

    The present value of future interest payments and the future redemption value are heavily influenced by the cost of debt, i.e. the rate of return required by bond investors. 

    This rate of return is influenced by the perceived risk of a company, for example as evidenced by its credit rating. 

    As the cost of debt increases, the market value of traded bonds decreases, and vice versa.

  6. Convertibility 

    If traded bonds are convertible into ordinary shares, the market price will be influenced by the likelihood of the future conversion and the expected conversion value, which is dependent on the current share price, the future share price growth rate and the conversion ratio.