A bond’s price is based on the bond’s underlying structure which includes, but is not limited to:
- Delivery date
- Maturity date
- Coupon
- Yield
- Call date, if applicable
- Redemption price (100% unless the bond is callable, then the call price)
Based on their structure, bonds can have several theoretical prices such as price-to-maturity or price-to-call. When purchased, an investor looks at all the theoretical bond prices and pays the lowest price, which will result in the highest yield for the investor.
When bonds are resold in a secondary market, the price will differ from the original price if market factors such as the borrower’s credit quality rating, capital markets, current yields, etc. have changed.
Example:
Suppose a borrower issues a 10-year bond with a face value of $1,000, an interest rate of 3.00%, an expected yield to maturity of 2.50%, and is callable in five years.
As this example shows, if the bond is called away from the investor by the borrower, they would pay $1,023.36 for the security, the price-to-call.
- If the bond is held to maturity and not called by the borrower, the price-to-maturity is approximately $1,044.00
- However, if the bond is called away from the investor by the borrower five years prior to the maturity date, the price-to-call is $1,023.36
What’s important here?
A bond’s price is based on many factors including the issuer’s credit quality, underlying market conditions, and the bond’s interest rate or coupon. Based on whether the bond is callable or non-callable, there could be multiple prices calculated for a specific bond. When purchasing a bond, the investor reviews all the possible prices of the bond and buys the bond for the cheapest calculated price.
