How is the Value of a Bond Determined?

With so many different bond issues available today, many first time investors are not sure how to go about determining the value of a bond. Fortunately, calculating bond values is a relatively straightforward process that focuses on understanding two key factors: the amount of interest the bond issue pays and the current status of the economy. Here is what you need to do in order to determine the true value of a bond.

One of the characteristics of the interest rate applied to a particular bond or group of bonds is that the rate is not subject to change, barring any attempts of the issuer to roll the bond issue over into a new offering. This is not true of other interest rates that apply to other types of investments. This means there is a good chance that the rate of interest locked in on a particular bond issue may be higher than the interest income that could be earned with other investment options. When this happens, investors are willing to pay more to purchase the bond issue, which in turn drives up the value of a bond.

This is an important concept to grasp when it comes to making an accurate bond calculation. By understanding that the interest earned from the bond will remain constant while other factors will vary, it is easy to see how the bond value could fluctuate as the economy shifts. When the interest rates offered by banks and others drops, the value of a bond issue increases in comparison. At the same time, if current economic conditions result in variable interest rates going up, then the bond value will decrease and become less attractive to prospective buyers.

Projecting the value of a bond issue before making the actual purchase is important. For example, a bond that will take five years to mature may offer an attractive rate of interest, based on current economic conditions. However, if there is a good chance the economy will undergo a period of inflation three years after the purchase, the relative worth of the bond during that inflationary period could be decreased significantly. In fact, the value of the bond may decrease to the point that the bond issue is not a good option in comparison to other investment options. When this is the case, the investor may achieve a better return by investing in bonds that will mature before the projected period of inflation commences and then reroute the earnings into investments that are likely to perform well during the inflationary period.

As with many investment strategies, it is important to manage investment activity so that the investor realizes the greatest return possible. By understanding how to determine the value of a bond issue over the life of the bond as well as the value of the bond at the point of purchase, investors can make more educated decisions about what should and should not be added to the portfolio.