Question

You can obtain the market price of bonds by

A: Adding all interest payments to be made over the term of the bond and the discount from Bonds Payable.
B: Deducting the bond premium from all interest payments to be made over the term of the bond.
C: Adding the present value of the principal paid at maturity and all interest payments to be made over the term of the bond.
D: Deducting the discount from Bonds Payable from the face value of the bond.

Answer 1

The market price of bonds can be calculated using the present discounted value (PDV), which factors in expected future payments and discounts them at the prevailing market interest rate. A bond's price will be less than the face value when its interest rate is below the market rate. Present value calculations can adjust for changes in the interest rate.

Step-by-step explanation:

To calculate the market price of bonds, the concept of present discounted value (PDV) is essential. PDV is used to determine what an investor should be willing to pay today for a series of expected future payments from a bond. This includes the payment of interest and the repayment of the bond's face value. When a bond's interest rate is below the market rate, its price will be less than its face value. For instance, if a bond with a face value of $1,000 is expected to pay $1,080 in one year, and the market interest rate is 12%, an alternative investment for $964 would yield the same $1,080 in a year's time. Therefore, the bond's price would not exceed $964.

Using Table C2's present value formula, let's consider a two-year bond issued for $3,000 at an 8% interest rate. At said rate, its present value equates to the sum of discounted values of all future payments. Should the interest rates increase to 11%, the bond's present value would decrease accordingly as the future payments would be discounted at this higher rate.