What Factors Affect the Present Value of a Bond?

Bonds are debt instruments that may be issued by both government entities and private enterprises. Various factors including the creditworthiness of the issuer, the bond term and the bond's features all have an impact on the present value of a bond. Bonds have terms that last for between six months and 30 years and longer-term bonds typically pay the highest interest rates.

When bonds are issued, credit rating agencies review the accounts of the bond issuer and attempt to gauge the financial health of the issuing entity. Agencies also review records pertaining to the issuer's past debt history. Bonds receive credit ratings based upon the agency's findings; bonds with high credit ratings usually end up paying low yields, while high-risk bonds pay higher rates of interest. The present value of a bond can change based upon changes in the issuer's credit rating. An improved credit rating may not impact a bond price but deterioration in the issuer's credit standing will normally cause the prices of outstanding bonds to fall.

In most instances, bondholders receive interest payments during the bond term and a return of premium upon maturity. The prices of short-term bonds tend to fluctuate very little since bondholders can get a return of premium by holding onto a bond for a few months. Conversely, the prices of multi-year bonds can vary greatly during the bond term as a result of interest rate movements. If the rates on newly issued bonds are higher than on previously issued bonds, then the present value of a bond issued in the past will decrease. The value of such a bond will increase if interest rates on newly issued bonds start to decline.

Some bonds include call options that enable the bond issuer to repay the debt prior to maturity. Generally, the issuer can only call in such bonds on particular dates during the bond term. As this date approaches, the present value of a bond rises or falls so that the going market price is roughly equal to its par value. Once the call date passes the value of the bond may fluctuate again based upon other factors such as supply and demand.

Many corporate bonds have a conversion option that allows bondholders to convert these debt instruments into stocks. Due to the conversion option, the present value of a bond will be impacted by the market value of the firm's stock. If the stock price drops then the conversion option becomes less valuable and the bonds drops in value. The opposite occurs when stock prices start to rise.