Price of Bond

This is nothing but various processes adopted to calculate the fair price of a bond. The calculation of price of bond is very much important for the investor. Any investor before making any investment decision in any bond must know whether it is fairly priced or under priced or else over priced. This help in investor making decision whether to purchase it or not.

The price of bond is usually calculated using 3 main approaches, they are Relative price approach, Arbitrage-free pricing approach, Clean and dirty price approach.  Even though there are quite a lot of other approaches that prevails, these three approaches are the one which are more popular and widely used.

Relative price approach is the approach in which the bond is compared with government security. The yield to maturity in this type is determined based on the credit rating that the organization got in relation to the similar security of government having same maturity period.

Arbitrage-free pricing approach is the one in which the current rational rate is calculated from the data of the future price of the bond. The calculation of future price include some assumption so arbitrage-free pricing approach needs some assumption to be made as well while calculation the current rational rate of it.

Clean price is the calculation of the bond value without including the interest accrued during the holding period of the bond. Dirty price is the calculation of the bond value with the inclusion of the interest accrued during the holding period of the bond by the holder.

The bond price determination is important in determining whether the investor can invest in the bond or not. Bond price gives an overall idea about the bond performance in the market. Usually the government bonds are taken as factor with which other bonds performance are compared, this is because the government bonds are termed to be the safest bond in the market. Government bonds are often termed as ideal bonds. Government bonds are termed as idea bonds because the investor are expected to get back the promised amount of money no matter what is the economic condition on the maturity period.