Bond Pricing

The current price of a bond equals the present value of all future interest payments and the present value of the principal repayment received when the bond matures.

When the sale price of a bond is below its face value, the bond has been discounted. A bond can sell below its face value in order to be competitive with rates of return of comparable bonds. A premium bond sells at a price greater than its face value. This situation can occur if the market interest rate falls below the interest rate stated on the bond.

There are two components to consider when pricing a bond. First you must discount all of the interest payments to the present. The second component is to discount the repayment of the principal to the present. The formula for calculating the price of a bond is:

Interest Portion = Sum of all years [ Annual Interest / (1 + interest rate)^ period number

Principal Potion = Face / ( 1 + interest rate)^life

Price = Interest Portion + Principal Portion