Why bond price matters
When you buy a bond, you are not just lending money. You are also reading the economy. Bond prices reflect interest rates, inflation, credit risk, and investor sentiment. Even if you never plan to trade bonds, understanding how prices move will help you see where the economy is headed.
A simple formula to remember
Price = Present Value of All Future Coupons + Present Value of Face Value
This formula may look abstract, but in practice it means every coupon payment and the repayment at maturity are discounted back using current market yields.
Bond price and yield move in opposite directions
- When yields rise, bond prices fall.
- When yields fall, bond prices rise.
This is the golden rule of fixed income.
Clean price vs dirty price
- Clean price: excludes accrued interest.
- Dirty price: clean price plus accrued interest, which is what you actually pay at settlement.
Example:
- Face value = $1000
- Coupon = 4% ($40 per year, or $20 semiannual)
- If 60 days have passed in a 182-day coupon period, accrued interest ≈ $6.59.
- So if the clean price is $980, the dirty price is $986.59.
Real-world example
- Bond A: 5-year, 4% coupon, face value $1000
- Market yield 5% → Price ≈ $956 (trades below par)
- Market yield 3% → Price ≈ $1046 (trades above par)
- Zero-coupon bond, 5 years, yield 5% → Price ≈ $781
Current Treasury Yield Snapshot (example, Aug 2025)
Maturity | Yield (approx) | Price sensitivity |
|---|---|---|
| 2-Year | 3.5% | Low |
| 5-Year | 3.7% | Medium |
| 10-Year | 4.0% | Higher |
| 30-Year | 4.2% | Highest |
Note: Longer maturities lose more value when yields rise.
Risk measures you must know
- Duration: shows how sensitive price is to yield changes.
- Modified duration: estimates % price change for a 1% yield move.
- Convexity: adjusts the estimate for bigger moves.
Example:
- 5-year bond at 5% yield has modified duration ≈ 4.5.
- A 0.5% rise in yield → ~-2.25% price drop.
Practical bond pricing cheat sheet
1. Check the quote type → Clean or dirty price?
2. Compare yields → Yield to maturity vs current yield.
3. Look at duration → Shorter = less sensitive.
4. Scan for credit risk → Corporate vs treasury vs municipal.
5. Mind the call date → Callable bonds may be repaid early.
6. Consider after-tax returns → Some bonds are tax-advantaged.
7. Watch inflation → Real return matters more than nominal yield.
Summary
Understanding bond prices gives you more than just investment knowledge. It helps you develop insight into interest rates and the economy, and it can guide you in anticipating trends in the stock and real estate markets.
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