Price of a Bond

A bond is a loan for n periods. The cash flows from the lender's viewpoint are shown in Table 4.1. The lender pays the borrower the price (P) at time 0. From time 1 through time n, the borrower repays in the form of a coupon (c). (This is an annuity.) At maturity (time n), the borrower pays the par (face) value to the lender.

Table 4.1 Bond cash flows received by lender

The price of bond is the present value of the cash flows. Namely,

Suppose we have a two-period bond with an annual coupon of $8 per period, a par value of $100, and interest rate of 10 percent. Then,

Treasury strips have no coupons, but simply pay par value at maturity. They are often called zero coupon bonds. The price of a strip is simply the present value of par: