Tuesday, October 9, 2007

How to Determine The Worth of a Bond

The value of a bond is determined by the interest that it pays along with the state of the economy. A bonds interest rate will never change even though other interest rates do. If the bond happens to be paying more interest than is available elsewhere, investors are willing to pay more to own it. If the bond is paying less the reverse happens. Interest rates and bond prices fluctuate like two sides of a seesaw. When interest rates drop, the value of a bond usually goes up. When rates climb the value of an existing bond usually drops. Several factors such as a bonds yield and return will affect whether or not a bond turns out to be a good investment.

If a bond investor buys a bond at par, and then holds it to maturity. The longer the maturity of the bond , the greater the risk that at some point inflation will rise dramatically and reduce the value of the dollar that the investor is repaid. If a bond pay more than the rate of inflation, the investor will come out a head. However many bonds, particularly those that have a maturity of five or more years, aren't held by one investor from the date of issue to the date of maturity. Investors will trade bonds in the secondary market. In the secondary market the prices of the bonds will fluctuate according to the interest that the bond pays, the degree of certainty of repayment and the overall economic conditions, especially the rate off inflation, which influences interest rates.

Yield is the amount of money that you will actually earn on a bond. If you purchase a ten year bond for $1,000.00 dollars that is paying 6% interest, and then you hold on to it until it matures, you will have earned $60.00 dollars, for ten years at the same interest rate. However if you purchase a bond in the secondary market, after the date of issue, the bonds yield might not be the same as its interest rate. This happens because the interest rate stays the same, but the price that you pay may vary, changing the yield.

Most bond charts express current yield as a percentage. Investors use the yield to compare the relative value of bonds. The return is what you make on the investment when the par value of the bond, and profit or loss from trading it, and the yield are computed.

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