Making an informed decision about whether to invest in a certain bond requires that you examine the bond's yield, present value, future value and the amount of its expected interest payments. Annual bonds typically accrue interest once per year, while the interest for semi-annual bonds accrues twice. The expected value of both the cumulative interest payments, as well as the final principal payment, help determine whether a bond is a solid investment. Investors usually seek bonds that yield more than their initial cost or selling price.
Sometimes referred to as the coupon rate, the interest rate of a bond is the percentage of annual interest that an investor will earn. Bonds that compound interest annually receive yearly interest payment equal to the interest rate times the bond's face value. The face value is the bond's principal payment or expected value at the end of its life. For example, a five-year bond with a face value of $100,000 and a coupon rate of 10 percent will yield a total of $50,000 worth of interest. If the bond compounds interest on a semi-annual basis, it will still yield the same amount of interest.
Number of Interest Payments
When calculating the amount of interest a bond will yield, the number of interest payments differs between annual and semi-annual bonds. The number of interest payments for an annual bond will equal the amount of years it will take for it to mature. Since semi-annual bonds receive interest payments every six months, the number of payments is equal to twice the amount of years until maturity. For instance, a five-year annual bond receives five interest payments, while a five-year semi-annual bond receives 10.
The future value of a bond is usually its face value. It is what the bond will be worth at its maturity date. A bond's face value is also what the investor will receive as a lump sum final payment, provided the investment is held until it matures. Whether a bond compounds interest on an annual or semi-annual basis, its face value may be the same. For example, a $100,000, five-year, 10 percent annual bond has a future value of $100,000. A $100,000 10-year, 5 percent semi-annual bond also has a future value of $100,000.
Calculating the present value of a bond's future expected payments is crucial to deciding whether it will be a beneficial investment. When an investor calculates the present value of an annual bond, the bond's future value, listed interest rate and the number of years until bond maturity remain the same. With a semi-annual bond, the bond's future value remains the same for the calculation. The listed interest rate is divided in half and the number of years until maturity is multiplied by two. For instance, if the present value of a semi-annual $100,000, five-year, 10 percent bond needed to be found, $100,000 would be used as the future value, 10 would be used as the number of payments, and 5 percent would be used as the interest rate. Present value is what a bond's future payments are worth today. If the present value is equal to its future value, it is said to be selling at par. Bonds that sell at a discount have present values less than their face values. Premium bonds are those whose present values exceed their future values.
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