The process of bond valuation is based on the fundamental concept that the current price of a security can be determined by calculating the present value of the cash flows that the security will generate in the future.
There is a consistent and predictable relationship between a bond’s coupon rate, its par value, a bondholder’s required return, and the bond’s resulting intrinsic value. Trading at a discount, trading at a premium, and trading at par refer to particular relationships between a bond’s intrinsic value and its par value. These result from the relationship between a bond’s coupon rate and a bondholder’s required rate of return.
Remember, a bond’s coupon rate partially determines the interest-based return that a bond (might/will)...........pay, and a bondholder’s required return reflects the return that a bondholder(would like/is obligated).............to receive from a given investment.
The mathematics of bond valuation imply a predictable relationship between the bond’s coupon rate, the bondholder’s required return, the bond’s par value, and its intrinsic value. These relationships can be summarized as follows:
• When the bond’s coupon rate is equal to the bondholder’s required return, the bond’s intrinsic value will equal its par value, and the bond will trade at par.