The selling price or the market value of a bond is the present value of the future cash derived from the bond. In other words, the semiannual interest payments and the payment of the face value of the bond at its maturity date will be discounted by the market interest rate. The resulting present value of those two amounts is the market value.

The semiannual interest payments are considered an annuity, since the bond's stated interest rate and the resulting interest payments do not change even though the market rates are changing each hour. The annuity consisting of the semiannual interest payments will be discounted by the current market interest rate (the rate an investor desires). The lump sum at maturity is a single payment and that too will be discounted by the same market rate used to discount the interest payments. The resulting present value of the lump sum plus the present value of the interest annuity will be the present value and the market value of the bond.

When market interest rates increase, the locked-in or fixed interest payments promised in the bond will become less attractive. Hence the present/market value of the bond will decline as the market demands higher interest payments. If market interest rates decrease, the locked-in or fixed interest payments promised in the bond will become more attractive and will result in a higher present/market value.

One caution for potential investors in bonds: Bonds will likely have a call feature. This means the issuer of the bond has the option to call in the bonds at a specified amount, such as 106% of its face value. This could mean a limit to the upside gain for an investor if interest rates decline. You should discuss this further with your financial adviser.

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