Intro: Calculating the Present Value of a AA Note Bond Using a Financial Calculator
In the financial world one of the most basic steps to understanding bonds is being able to calculate their value at any given time provided that you have the financial information. A bond is a debt security that pays a fixed amount of interest on specified dates until it matures. The face value of a bond is usually $1000, and is returned to the bondholder at maturity. Bonds are an important financial tool for all investors. The low steady yield that bonds offer provide you with a safety net to protect more high risk investments.
• A Financial Calculator (We will be using the HP 10b11+)
• A Bond that you will be evaluating
• The length of the bond
• The annual or semiannual payments of the bond
• The future value of the bond
• The market rate or the bond
Estimated time for completion ~~ 10-15 minutes
Step 1: Turning on the Calculator
First make sure your calculator has batteries and is in working condition.
Once you have verified that the calculator has a working battery, you will be turning on the calculator. The "on" button is located at the bottom left hand corner of the calculator. Press it once and the calculator will turn on.
Step 2: Clearing the Calculator
In order to get the desired results you must first clear the calculator. This can be done by first hitting the RED function key located on the far left side three buttons up from the bottom and then hitting the C button right bellow the function key. This combination will clear the whole log and the calculator will be primed for use.
Step 3: Inserting the Payment Amount
To insert the payment amount (ex. 30) you must first determine the amount that your bond pays and how often. For simplicity we will assume that the bond is being paid annually at the end of the year. The payment is usually expressed by the coupon rate. After you have determined what your annual payment is you type in the amount into the calculator then you press the PMT button to save the payment amount.
Step 4: Inserting the Future Value
The future value of the bond in most cases will always be 1000. This is because most bonds mature at $1000, but are sold at either a premium or at a discount. Don't be surprised if the future value of the bond isn't expressly stated in the problem you are working. If the value is not specified assume the future value is 1000. Press 1000 on the calculator then hit FV to save your future value input into the calculator.
Step 5: Inputting the Number of Years It Will Take the Bond to Mature
Most bonds are dated for 10, 15, 20, or 30 years, this will usually be stated on the front of the bond and will help you in your calculation of the present value. To input the life of the bond you enter the number of years the bond will take to mature then hit the N button to save your data into the calculator.
Step 6: Inserting the Market Rate or Desired Rate of Return
The last thing you will need to calculate is the market rate. The market rate is the percentage of the bond that is being sold in the free market. This value can also be the desired rate of return if you have a certain value that you wished to be returned. You input this the same way you have been inserting your other data that should still be saved into the calculator memory. Hit the value of your market rate and press the I/YR button to save the data.
Step 7: Finding the Present Value of Your Bond
Now that all your other data has been inputted into the financial calculator, you simply need to press the PV button to obtain the results. The value you see should be a negative number, but not to fear just simply remove the negative sign and there is your final answer. Lets put this into practice in the next step!
Step 8: Example Problem 1
Find the value of a 5% coupon rate AA noted 30 year bond, if the market rate is 8%?
First clear your calculator to get normal results!
The Payment is $50 because it is 5% and is being paid annually. If the number was 7% it would be a payment of $70 instead.
PMT --> 50
The future value as stated earlier is 1000 even if it is not stated in the problem.
FV --> 1000
The number of years is expressed in the problem as 30 years.
N --> 30
The market rate is 8% and there is no desired rate of return so we use the 8% market rate.
I/YR --> 8
Press PV and your answer should be $662.27, don't forget to get rid of that negative sign to get the correct answer.
Step 9: Example Problem 2
This example will be a do it your self problem to see if you understand the concept and can apply it without any walk through help.
Find the PV of a 27 year AA bond with a 4% coupon rate and a market value of 6.5%.
The PV should be $685.63
Good luck in solving all of these types of problems, just don't over think them. You can solve for any part of these types of equations the exact same way depending on what data you are given and what you are missing. If you are given the PV and need the FV just insert everything but the FV and for the final step just hit FV at the end instead of PV.