Thursday, March 27, 2014

Calculation Of A Price For Bond

By Jaclyn Hurley


In most cases, the valuation of the securities being traded within a specified market is determined by interplay of factors. The demand and supply of such commodities often determines the much that the traders are likely to part with in order to acquire such securities. The higher the demand of a commodity within the markets, the higher the face value. A price for bond has to take into consideration the demand the supply factors too.

Cash flows from investments are mainly in form of returns and costs. The future cash flows can used in estimation of the prices at which the assets will be traded at. The cash flows are discounted at the relevant rate of discount to arrive at the present market prices. The costs have to be deduced from the returns when determining the returns from an investment.

There are very many classes of bonds that are traded in the different markets. Some of the bonds have the options of conversion after maturity. This means that the owners can convert the bonds into other forms of securities after the date of maturity. The embedded options give the owners a chance to change them into a number of equity options depending on the price.

The rate of return, the discount rates and the cost of capital are some of the data that needs to be collected before determining the profitability of an investment. In some cases, the data may be very hard to collect. This means that traders have to use other forms of pricing in arriving at the prices. Most traders use the relative pricing strategy. The prices are estimated using benchmarks such the corporate and the government gilts.

Segregation of cash flows is done in different markets so as to separate the costs from the returns. This means that each of them is rated using a different rate. Some may be treated as zero-rated coupons. The use of coupons helps the traders to determine the rate of returns and general profitability in the general markets. Bundling of rates may also be done.

Finance and business risks are the main types of risks that the traders have to face in different markets. The finance risk is associated with the type of investment in question. Embedded bonds are priced higher than the plain bonds. Business risk factors in the industry in which the firm in question operates.

Modeling is often done in scenarios where there is a need to put the specific risks into consideration. Interest rates derivative is used in the building a scenario. The model recognizes that most of the interest rates and rates of returns are uncertain. Specific equations are used for estimating the likely rates of returns. This is done by plugging the current rates into the equation so as to estimate the future rates.

There is a need to ensure that accuracy is observed during the calculations and the estimations. In cases where approximations are to be made, prudence in estimation should be observed. This ensures that the movements within the bonds band remain within the estimated range. This avoids giving the wrong pieces of information to the traders.




About the Author:



No comments:

Post a Comment