BOND PRICES,DISCOUNT FACTORS AND ARBITRAGE

Bond prices are usually at any one of these three levels. They are either at par, at premium or at discount. If the bond is selling at a value lesser than its par value then it is said to be in discount level. When the bond is selling at a value greater than par value then it is said to be selling at premium level. Bonds par value prices are usually calculated manually in order to identify the maximum price an investor can invest in that particular bond. When calculating the bond par value prices the yield and rate of return taken into consideration.

 Discount factor is nothing but a factor which when multiplied with the future cash flow gives the current value of that cash flow. Discount factor are highly useful for the managers who have a target profit in mind to be achieved in the future. The discount factor will help the managers in decision making with regards to the fund handling. The discount rate is used to find the discount factor. Discount factor is the opposite of the interest rate. In the case of interest rate it is moving forward, whereas in discount factor it is moving backward. Some assumptions were made while calculating the discount factor.  These assumptions are,

• The discount rate is fixed through out the years of calculation.
• Economic condition is stable throughout the years of calculation.

Arbitrage is the process by which a product is purchased in one market and sold in another market simultaneously and gaining profit from the price fluctuation that prevails in the two markets. For example if the price of oil in USA is 74 $ a barrel whereas the price of oil in India is 84 $ a barrel, then an investor can buy the oil from USA and sell it in India. This kind of arbitrage is usually practiced in currency trading. A person who does this kind of business is called arbitrageur. Some of the conditions that need to be satisfied for a smooth arbitrage are,

• The cost of the same asset varies with varying markets.
• The asset has a very negligible cost of storage
• The asset never trade in futuristic prices at any given time in the present.