[Anonymous]

Okay so I can generally work out a problem for Bonds with premiums and discounts, but I think I am having trouble with the conceptual understanding of why people would purchase a bond.

Okay so if I purchase a 10 year 10% X Co. Bond at par for 1,000,000 then I pay 1,000,000 now and then I receive payments over 10 years of $100,000 annually.

My question, why would I buy that bond at all??

1,000,000 is worth more now than it is in 10 years, so why would I give a company 1,000,000 now to receive the same 1,000,000 in the future?

the same applies to bonds at premiums even more so. Why would I pay a company 1,081,105 to receive 1,000,000 back in 10 years?

Let me know if I’m completely misunderstanding something here please, Thanks!

[acamp]

You're not counting the 10%, $1M bond, 10%, at par, means you'll put up $1M, get $100K per year and get your $1M back at the end.

For premium and discounts, its just the market's way of responding to that 10% in consideration of prevailing interest rate. if the market is only paying 2% on average for a bond of similar risk, than the price of that $1M par bond which pays 10% will be higher than the face value which brings the bond's overall yield down closer or to the 2%.

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[Anonymous]

Ahhh.. I gotcha!

Okay so When A bond is discounted to say

PV of an Annuity $1 at 6% for 10 period= $368,005 – that is the present value equivalent of the $500,000 interest to be earned

PV of $1 for the principal amount 1,000,000 6% 10 periods= $558390

that is the equivalent of $50,000 x 10 periods = $500,000 in interest

and

$1,000,000 principal

for a total of $1,500,000 which discounted 10 periods in the future equals the equivalent of $926,395

So to compensate for paying a lower yield at maturity the investor only has to pay $926,395 instead of $1,000,000

Wow that makes so much more sense, I was thinking of the discounted cash in terms of total value, and not looking at it as though it had been discounted.

I'm sure that makes no sense, but I'm currently just doing a stream of consciousness of my thought process and now I think I'm good!

Haha i've bee trying to figure out why bonds made no sense and now I know why! Thanks!!

[Author]

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