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The AAA bond rating represents the current market interest rate for the bonds which has credit rating of AAA is 5%. The coupon rate of the bond is 5%. Let us assume the number of years to maturity is 1year and face value to be $100: Interest = Face value * Coupon rate = $100*5% = $5 Using the equation Price of bond = Interest/(1+Yield to maturity)1 + Face value/(1+Yield to maturity)1 = $5/(1+0.05)+$100/(1+0.05) = $4.76+$95.24 = $100 Let us increase the time to maturity to 3 years: In this case, one has to use PVIFA table to determine the value @5% for 3 years or using the below formula. PVIFA @3% for 5 years =1 - (1.05)3/0.05 = 2.7232 Price of bond = Interest * PVIFA @5% for 3 years + Face value/(1+Yield to maturity)3 = $5 * 2.7232+$100/(1+0.05)3 = $13.62+$86.38 = $100
In this case the bond is selling at par
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Aug 14th, 2015
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