Question

I know that I have to Discount all future cash flows of a bond and the...

I know that I have to Discount all future cash flows of a bond and the principal value in order to obtain its value. However, do I have to Discount with YTM or the market interest rate? Do I obtain 2 different "bond values" in both of the cases? Does one have to do with the market value of the bond? I did not really get the difference. between both cases. TIA

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Answer #1

The discounting of the future cash flows of the bond is to be calculated using the yield to maturity and not the market interest rate. This is because the yield to maturity is the rate of return that the bondholder would earn if he/she invested the coupon payment in the bond. The market interest rate has no role to play here.

Yes, the values will be different as both the rates are different. The bond values will be different if these values are used.

The face value of the bond has to be used for the calculation or the coupon payments may have to be considered. Market value need not be considered.

The use of the market value of bond is only to know if the bond is sold then how much would the bondholder earn. So, it is not used for any calculation.

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