The Maximum Price of a Bond

posted on: Monday, December 13th, 2010, 15:20

A big difference between plain vanilla bonds and dividend paying stocks is that the bonds have a maximum value while the stocks do not. The maximum value of a bond is its price at zero yield. You get that price by just adding up all the remaining coupon payments plus the principle. Only a fool would pay more than the zero yield price for a bond. If you pay more, then the yield is negative.

If you divide the current price of a bond by its maximum price, you get something like an average discount factor for all of the remaining cash flows. From this you can get a first crude estimate of the yield to maturity. But you can also use the ratio by itself as a way to benchmark bonds. The closer the ratio is to 1, the more expensive the bond.

© 2010-2012 Stefan Hollos and Richard Hollos

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