| Bond Main Page | Table of Contents | Corporate Finance Course |
 

Valuing Corporate Bonds in the Secondary Market

After the bonds have been issued in the primary market and sold to investors, the investors in turn, may sell these bonds to other investors. When one investor sell to another investor., the trade is said to occur in the secondary market where transactions can take place either on an exchange or in over-the-counter market.

In the secondary market transactions, the bond does not have to be traded for its original issue price. That means that the selling party may sell the bond at a profit or a loss. Essentially, three main factors determine the resale value of a bond: 

  •  The relative change in market interest rates. 
  • The change in the credit quality of the bond. 
  • The relative supply of and demand for, bonds. 
Changes in Interest Rates
If, after a bond is issued, interest rates should rise, then the market value of the bond falls.
For example, XYZ, Inc. issues an "A-rated," 30-year, 8% bond (a bond that pays $80 of interest a year). Investor A, buys one of the bonds. Five years later, he wishes to sell the bond (which now has 25 years left to maturity) but newly issued A-rated, 25-year bonds are now yielding 10%. If A tries to sell the bond for its full value, he will find that his bond's lower yield makes it uncompetitive relative to the new 25-year bond offerings. In order to make the bond attractive to investors, investor A must price it so that it is offers a competitive return. Since the bond pays $80 per year and must yield 10% to be competitive, the price must be around $800 for it to be attractive to potential investors [($80/$800) X 100 = 10%]. 
 
On the other hand, should interest rates go down, the investor A can sell the bond at a profit. Fluatuations in market interest rates are probably the most important factor in determining the market value of a bond. Unfortunately, since no one can accurately predict future interest rates, no one can accuratel;y forecast future bond prices.

Credit Rating
If, after a bond is issued and its quality should either improve or decline, the market value of the bond will be adjusted accordingly by the market.

Supply and Demand 
From time to time, the relative supply of bonds changes with respect to the demand for them. During the period when bonds are in relatively short supply, investors wishing to sell get a better price than when there is a surplus of bonds on the market. Often tax changes bring a flood of new bond offerings that temporarily depress the bond market.

| Bond Main Page | Table of Contents | Corporate Finance Course |

This page is created by Julia Lee '99 and is maintained by Professor Satyananda Gabriel of the Economics Department, Mount Holyoke College, January 1999.