Market price
The market price of a bond is normally expressed in terms of a $100 par value. A bond trading at $90 is said to be trading at a discount. A bond with a market price of $110 is said to be trading at a premium. The price of a bond represents the present value of its discounted coupon payments and the principal amount. In the case of a zero-coupon or strip bond, the market value is discounted value of the coupon or residue, which likewise is expressed in terms of a maturity value of $100. A strip bond with a long term to maturity may be trading a deep discount - for example less than $20.
If the maturity value of a strip bond is $10,000 and its current price is expressed as $20, the market value of the investment is $2,000. Similarly, if the price of a regular bond is $110 on a maturity value of $5,000, the market value of the bond is $5,500.
The price of a bond is affected by changes in interest rates and the credit worthiness of the issuer. The interest rate of a bond - also known as its nominal or coupon rate - is normally fixed. Consequently, changes to prevailing market rates can cause a bond to trade at a discount or premium. If market rates increase, the price of a bond declines. The price of a bond generally increases if market rates decline.
The discount rate on a bond normally takes into account prevailing market rates and the risk-characteristics of both the bond and its issuer. The issuer of a callable bond - which may be redeemed by the issuer prior to maturity - generally has to be offered at a higher yield to attract investors. Corporate bonds are normally considered of higher risk than government bonds because of the likelihood of default. Government bonds tend to have lower yields than corporate bonds.
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