Why does the prices of Bonds or any fixed interest bearing instrument goes down?
Bonds and Debt instruments such as debentures in India have the flactuating valuations. what factors determine the spot prices of debentures or any instruments having fixed interest rates affixed to them?
Why does rates of debentures flactuate?
What are the factors that affects the spot price of debentures?
Nothing on market is valued on fixed price. Prices of every security instrument flactuates.
The logic of Debenture having fixed interest rate is not valid to value a debenture on the fixed price.
The main factor that affects the valuation of debentures is running Interest Rate. The other factors which have an impact on pricing of debentures are Return on equities and other instruments.
Why does current Interest Rates affects the valuation of Bonds?
Interest rate affixed to debentures are the returns which a debenture will give. Interest rate is fixed, so is the return on money invested in Debentures.
The debenture is discounted at current running interest rate, the discounted value of debenture may be higher or lower than the face value of debenture.
Example: Suppose you have a debenture of 1000 Rs. with interest rate 8%. The current interest rate prevailing in market is 10%.
The debenture is to redeemed after a year. If a person purchase debenture from you at 1000 Rs., interest he will earn is limited to 80 Rs.
If he invest the same money in some other instrument the interest he will receive is 100 Rs. Ofcourse the debenture will be valued at a price which can provide return of 10% to buyer.
The value of your debenture will be calculated as follow:
(Face value of Debenture+Interest to be received) devided by value of debenture equals to 110%.
So, the current value of Debenture will be:
Value of Debenture is 980~.