Bonds and Interest Rates Essay Example | Topics and Well Written Essays - 500 words

Bonds and Interest Rates - Essay Example When interest rates go up compared to the coupon rate, bond prices would fall in the market and when interest rates fall, bond prices would go up.   Bond price and interest rates have an inverse relationship. When interest rates go up compared to the coupon rate, bond prices would fall in the market and when interest rates fall, bond prices would go up.   2. The calculations involved with pricing a bond and a stock a) A bond is priced by converting the future cash flows from the coupon rate and the maturity payment to their present value. The discount rate for calculating the present value is the investor’s required yield.  The formula is shown below. An Excel worksheet has PV calculation as a built-in macro.  Bond Price =    C / (1+r)) + C / (1+r) 2 †¦Ã¢â‚¬ ¦Ã¢â‚¬ ¦Ã¢â‚¬ ¦Ã¢â‚¬ ¦   C / (1+r) n    + M / (1+r) nWhere,    ‘C’ is the Coupon rate                          Ã¢â‚¬Ëœn’ are the number of payments         à ‚                 Ã¢â‚¬Ëœr’ is investor’s required yield  Ã‚                        M is the maturity value of the bond   Ã‚     b) The price of a stock is determined using the Dividend Discount Model where the future dividends to be paid out by the company are discounted to a present value. An assumption often made is that there would be a growth in the rate of payment of dividends as the company grows in the future.