Discussion:
Bond Valuation: Three Important Relationships
(1) First relationship
The intrinsic value of a bond is inversely related to its required rate of return. Since the required rate of return depends positively on the market interest rate, we can infer that as market interest rate increases (decreases), bond value decreases (increases). The change in value caused by changing interest rates is called interest rate risk.
(2) Second relationship
1. If the bondholder's required rate of return equals the coupon interest rate, the bond will be valued at par, or maturity value. This is said to "trade-at par".
2. If the required rate of return exceeds the bond's coupon rate, the bond will be valued below par or at a "discount." This is called a discount bond.
3. If the required rate of return is less than the bond's coupon rate, the bond will be valued above par or at a "premium." This is called a premium bond.
(3) Third relationship
Longer-term bonds are exposed to greater interest rate risk than shorter-term bonds.