Instrument types 16 - Bonds - The Price of a Bond

By IU AU

October 25, 2021

Instrument types 16 - Bonds - The Price of a Bond

The secondary market is the market in which all bonds trade. Once the initial primary market issue has taken place. It's in this secondary market that the price for bond is important for bond investors. We need to understand the quoted price for a bond known as the clean price. In this first topic, we begin by showing you how to calculate the cash equivalent of the clean price of the bond.

When you buy a bond, the amount that is actually paid, it's an invoice amount based on the dirty price of the bond. This introduces the coupon, a cruel process. And we'll explain why the investor pays the dirty price for a bond, rather than just the clean traded price. We will look at the terms clean and dirty in the following page.

The objective of this first tutorial on bond pricing is to help you understand the prices quoted for bonds and how the price is applied to a trade to calculate an invoice price. In the next tutorial on bond pricing, we'll look at the main reasons why bond prices are continually subject to change.

First of all, let's take a look at prices quoted for. The bond price you see on a trading screen is a percentage price. It's applied as a percentage of the face value of the bond. Let's look at some examples to illustrate this calculation. You buy a bond with a face value of a hundred thousand euros. The offer price quoted in the market is 105.49.

This is known as the clean price of the book. All buy and sell trades are based on a bid offer, clean price. There's also a dirty price for a bond. We will explain later in this tutorial. So based on this clean price, how much do we pay? It would be 100,000 euros times 105.49%, which is 105,490 euros. When a bond is trading above a hundred percent of its face.

We refer to it as trading at a premium to par suppose the clean price has been 94.51. We would have to pay 100,000 euros the face value of the bond times 94.51%, which is 94,510 euros. When a bond is trading below its face value, we refer to it as trading at a discount to par. Let's look at one more example of this principle to make it absolutely clear using the same prices.

Let us assume that the face value of the bond is now 150,000 euros. This means that the amounts we pay would be 150,000 times 105.49%, which is 158,235 euros or. 150,000 times 94.5, 1%, which is 141,765 euros. The rule is multiplied the face value of the bond by the clean price percentage to arrive at the cash value.

We've seen that the bond investor pays the clean price when they buy a. However, the investor has also got to pay for the current accrued coupon on the bond. So what does this mean once again, let's work through an example to explain the process. On the 1st of December, 2016, what we call the settlement date in the bond market, we decide to buy the bond shown here with a face value of $100,000.

The clean price is 101.9, 8%. However, we also have to pay the accrued interest since the last coupon was paid on the 20th of June, 2016. Our broker advises us that the accrued coupon is 2.24%, and that the dirty price of the bond is therefore 104.2, 2%. That's the clean price of 101.9, 8%. Plus the accrued interest of 2.2, 4%.

To buy this bond. We therefore have to pay $100,000 times 104.2, 2%, which is a total of $104,220. So what exactly is the accrued coupon on a bond to understand this? We need to know who owned the bond. And when we bought this bond on the 1st of December, 2016, so on that date, it belongs to. But someone else owned it before that date and will expect to get the value of Edie coupons up until the 1st of December, this is a us treasury bond.