The price that investors pay, or are willing to pay, for a bond. Intrinsically, bond prices are linked to the interest rate prevailing in the market where a bond trades. The connection with interest rate is typically negatively correlated: bond prices fall as interest rates rise, and vice versa. Bond prices are determined in a way that investors can get a certain return on their bond holdings.
Bond price depends on a number of key, unique factors relating to a given bond:
- Coupon (or zero coupon)
- Par value (principal)
- Yield to maturity (YTM)
- Resetting/ fixing intervals
Bonds are priced in different ways to reflect economic reality for all parties involved (issuers and investors): a bond that sells at a premium (that is, the bond price is higher than par value) is expected to have a yield to maturity (YTM) that is lower than its coupon rate, and vice versa. A bond could sell at a higher price if the coupon rate is larger than the expected yield (market interest rate). A bondholder will pay a premium for the bond that provides coupon payments that exceed the market interest rate. The opposite is true for bonds that sell at a discount.
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