Fundamentals of Financial Management, Third Edition

4.3 FACTORS INFLUENCING BOND VALUATION

4.3.1 Discount Rate versus Coupon Rate

The relationship between the discount rate and the coupon rate has an impact on the market value of a bond. If the coupon rate is equal to the required rate of return, the market value will be equal to the par value. The bond is then said to be selling at par.

 

EXAMPLE

If a 3-year-maturity bond pays Rs 50 as interest per annum and has a Rs 1,000 maturity value, its value at the time of issue at a discount rate of 5% will be:

 

V_d = (50/1.05) + (50/1.05²) + (1050/1.05³)

        = Rs 47.62 + 45.35 + 907.03 = Rs 1000.

If the required rate of return or the discount rate is lower than the coupon rate, the market value of the bond would be greater than the par value. ...