EBS FINANCE Salwa Dagher The bond price is the present value of the bond’s cash flows, discounted by the set of spot rates. Bond price = cf1 + cf2 + cf3 + cf4 + cfn (1+i) (1+i)2 (1+i)3 (1+i)4 (1+i)n Face value: also known as ‘Par value’ or ‘Nominal value’ or ‘principle’. This is usually the issue price of the bond. In the UK this will be £100, in the US and Europe it will be $1000 or €1000. Coupon: This is the income return that the bondholder receives. The coupon is usually expressed as a percentage The bondholder will receive this every year through until the maturity of the bond. The level of the coupon depends on the creditworthiness of the company. The more creditworthy the company is, the lower the coupon, because there is low risk of the bondholder not being repaid at the maturity of the bond. Maturity: This is when the bond is due for repayment (the company has to pay back the face value of the bond for all the bondholders). The redemption value of the bond is the same as the face value of the bond (£100, $1000, or €1000). Market price of bond: The bond will be sold at face value (£100, $1000, or €1000), but once it is on the market, the bond price may move away from that face value. The two major factors that affect the bond price are; 1. The term structure of interest rates The cash flows of the bond will be discounted by the appropriate rates for each time period from the term structure. So this means that the bond price is affected by the set of interest rates that dictate the direction of the economy. If the economy is in recession, interest rates will be low and as a result, bond prices will be high 2. The creditworthiness of the borrower. If this deteriorates, then the interest rates for the borrower will go up. So the individual term structure for the borrower will see a widening spread over the risk free rate of interest Types of bond: 1. Fixed rate bond: This is the most popular, it has a fixed coupon and the borrower pays that rate through