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# Bonds watch

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1. I'm sorry if this is in the wrong section so please move if it is but I just had a question about bonds and it might be a very stupid one but I just can't understand it.

Now I understand what bonds are and everything but what I don't understand is the market for them. I was reading something on them and it said you can buy a \$1000 government bond that gives, say, 2% interest pa. Now what I can't understand is when it says that this bond is worth, say, \$1200. I mean I completely understand demand and supply (or so I hope) but why would anyone buy it for \$1200 when they could buy it from the government for \$1000?
2. Maybe they can't. Maybe the government is only offering bonds (of the same maturity) that pay 0.5% interest at the time.
3. The value of a bond is the sum of the present value of all its future cashflows: a "\$1000 Treasury bond" is worth more than \$1000. You're not talking about a bond that you buy for \$1000 but a bond that will pay you \$1000 at maturity so in 1 year, 5 years, 25 years.. In addition to this "nominal value" or "face value" that is paid at maturity, you receive interest paid at a certain percent, at a certain frequency (once a year, twice a year usually, maybe one a month) that is usually agreed at purchase.

So the value of your bond is the sum of the present value of the \$1000 being paid at maturity PLUS the present value of those future 2% interest payments paid annually (or semi-annually) so it might be above \$1000 (but not always). \$1000 paid in 25 years is worth less than \$1000 paid today, that is usually a fundamental reasoning behind bond valuation but the interest payments make up for this, to the point that if the interest rate is high enough, the present value of a \$1000 bond CAN be higher than \$1000 but it can also be lower.
4. (Original post by SamTheMan)
The value of a bond is the sum of the present value of all its future cashflows: a "\$1000 Treasury bond" is worth more than \$1000. You're not talking about a bond that you buy for \$1000 but a bond that will pay you \$1000 at maturity so in 1 year, 5 years, 25 years.. In addition to this "nominal value" or "face value" that is paid at maturity, you receive interest paid at a certain percent, at a certain frequency (once a year, twice a year usually, maybe one a month) that is usually agreed at purchase.

So the value of your bond is the sum of the present value of the \$1000 being paid at maturity PLUS the present value of those future 2% interest payments paid annually (or semi-annually) so it might be above \$1000 (but not always). \$1000 paid in 25 years is worth less than \$1000 paid today, that is usually a fundamental reasoning behind bond valuation but the interest payments make up for this, to the point that if the interest rate is high enough, the present value of a \$1000 bond CAN be higher than \$1000 but it can also be lower.
well done for mentioning inflation risk btw.

squish.
5. (Original post by xps.systems)
well done for mentioning inflation risk btw.

squish.
It's called bond discounting (if I remember my CFA material. I can go digging otherwise. I don't do anything with bonds now or even most financial instruments). It's not so much due to inflation (although yes this is all related) than the fact that an amount in the future needs to be "discounted". It's also because you can invest that money in no-risk products such as Treasury Bonds (which are usually used as the reference for all other bonds and debt market products). Why wait for \$1000 paid in 1 year when you could just take \$990 now and earn the no-risk interest rate on it and end up with more?
6. Very basic assumption: -> Not all US govt bonds are at 2%. Some are higher, some are lower. Those that pay higher coupon relative to today's IR are trading higher than those that are not.
7. (Original post by uthinkilltellu)
Very basic assumption: -> Not all US govt bonds are at 2%. Some are higher, some are lower. Those that pay higher coupon relative to today's IR are trading higher than those that are not.
Uthink, delete some messages from your inbox!

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