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Right Way To Bond Valuation
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How much you are willing to pay for purchasing a bond?
In short, the future cash flow that you earn by owning a bond known as bond value. Now the question is where this cash flow will come from? There are two sources from where these earnings or cash flow comes in. The first is the coupon payments. Coupon payments are the earning for the holder or owner of the bond. The second source is the face value of the bond or the repayment of principal.
Let’s consider an example. You have got a bond of $1,000. By using bond valuation formula and assuming a 5% rate of interest from a bank and a 4% coupon rate, you can simply earn $4 per year for 7 years, provided your own it. Along with it, you get back the face value after 7 years and it simply means that you earn $941 after the end of 7 years. And this amount is lower than the face value which is $1,000. No matter what is the face value, you will be willing to pay $ 941 taking the future cash flow into consideration.
The formula for bond valuation is a bit complicated and it takes many other things into consideration. They are – the source or the source to maturity, the time left for maturity and other important variables. However, you don’t have to do these complicated calculations. Just pick up a calculator and get your job done easily.
What exactly the amount $941 stands for as discussed? Paying more than $941 is not wise. In this case, you can put this money in a back instead. The reason behind this decision is quite clear and it’s all about your earning. The better between these two options is depositing in bank.
Another important question is when you buy or sale a bond, which value to consider the face value of the fair value?
Generally, when it’s the first time a bond is being sold or issued by a company, the transactions take place at face value. In the next step when a bond is brought or sold by any person, it is done at the market value. And this market value is the difference between face and fair value. Moreover, this is the value that people are really offering to pay for the bond. No matter even if this is less or more than face value or fair value. Nonetheless, market values are closer to both the face value and fair value of a bond.
The Bottom Line-
In order to ascertain the fair value of a bond, you can use an advanced calculator online or can talk to an expert. Before you jump into this project of bond selling and purchasing, you must know what the real value of a bond is and how much you can pay.
No matter when you start buying and selling bonds- you must know how to make a profit on investment. Bond valuation is the first step among others.
No matter which market you are purchasing your bond from, knowing the real value of it is essential and important. Bond valuation helps you invest in the wisest way and promises to bring higher return from bond purchase and selling processes. Be careful and gear up with the right valuation process today.
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