16. How to use a Bond Calculator Video Lecture | Become an Expert: Value Investing - Business Basics

welcome the course to unit 2 lesson for
calculating the value of a belong in
this lesson we're going to learn how
does the price of a bond change with
interest rates and how to use the
buffett's folks comm bond calculator so
let's get started
so if you're like most people math
really makes your head hurt and here at
Buffett's books we've made it easy for
you and we've made a bond calculator
that does all the hard math for you so
instead of focusing on the equations you
can focus on the fundamentals and why
the numbers move in a certain direction
so let's go ahead and kick this off with
a practical example here and let's
assume that you purchased one bond in
the year 2012 and that the par value for
the bond was $1000 it has a 5% coupon
and the term on it is for 30 years now
if that didn't make any sense you
probably need to go back to the very
first course here at Buffett's books and
take those lessons so you understand
what those terms mean and then you can
come back to this lesson so let's go
ahead and see what happens to that bond
and we're going to try to figure out
what that market price is going to do
for that bond one year later as interest
rates change so here we are holding our
5% bond and it's one year later and
interest rates have dropped which is a
good thing as you remember our bonuses
but interest rates dropped on the 4% and
the Federal Reserve is now issuing a
thousand-dollar bond with the term limit
of 30 years at a 4% coupon so what is
the value of the bond that we're holding
that's a 5% bond because now we're
holding the more valuable asset
but there's only 29 years until it
matures where the other one's 30 so
let's figure out what our bond is worth
okay so here we are at the Buffett's
books.com bond calculator and what we're
gonna do is we're gonna put in these
values the first value that we got to
put in is the coupon which is in a
dollar amount so when we look at the
bond that we purchased in 2012 it had a
5% coupon so the bond calculator will
only take the values in dollar so you're
gonna have to do the conversion here
which a 5% coupon with thousand dollar
par value is 50 dollars so you're going
to put that in now realize that I've
made the calculator for an
annual calculation so if it's a biannual
bond that's something that you'd have to
go to a more advanced calculator with
but this is just to give you a general
idea of how these market prices change
with interest rates so we're just going
to add up the coupons for the year which
would be $50 because you probably
received two $25 coupons so it'd be $50
for the year now the par value is just a
thousand and make sure you don't put any
dollar signs in there you just put the
numbers in then the years to maturity
since we bought it and we've held it for
one year or years to maturity are going
to be 29 years now the new interest rate
of the bond that we are going to be
comparing this to is 4% okay that
interest rate went down and all you got
to do is just put in 4 you don't have to
put any decimal or put it in as point
zero 4 you're just going to put it in s
4 then you hit calculate and as you can
see the bond price increased our bond
that we're holding is worth 1000 $169
the reason that's worth more in that
your that you could sell it for a
premium is because the best that
somebody can go out and get is 4 percent
and if you would add up all those coupon
payments for the next 29 years with that
4 percent bond it would the price would
equal this 1169 with the 5% bonds that's
why you're able to charge a premium for
it so what would happen if we change the
years to maturity so that there was only
a few years left until this bond became
mature would you see that bond price go
up or go down so let's put that in let's
just put in 1 year left on this bond so
this would be like you held this bond
for 29 years and there's only one year
left on this 5% bond and you're
comparing it to a bond that has a 4%
coupon so what you're going to see is
that the price goes down to one thousand
and nine dollars the reason you saw that
price go down so much is because the if
a person's going to go out and buy this
5% bond from you and there's only one
year left what do they get back at the
end of the of when the bond matures they
only get that parfait
value back they get the thousand dollars
back so they're only going to reap the
benefits of buying a bond that's only
paying 1% more than what they can go out
and get for one year so that's why you
see that price change you see it only go
up by nine to ten dollars but when that
bond has a lot of term left on it and
those interest rates go down you can see
the value increases a lot especially for
only owning it for one year let's say
the interest rates went down the 3% look
how much that bond price changed it's
almost a 1400 dollar bond
you almost gained four hundred dollars
in one year because you had had such a
drastic change in your interest rates so
you can see as those interest rates go
down the bond price goes up so let's go
ahead and look at it at another scenario
okay let's assume that we still bought
the same bond in 2012 which is a 5%
coupon but this time instead of the
coupon on the newly issued bonds in 2013
instead of them being at 4% let's say
that the interest rates went up and now
they're it's 6% so we're just going to
come back over here to our calculator
our coupon is still the same our par
value is still the same we're still
going to say that there's 29 years left
because we only advanced one year but
now the interest rate is 6% now what do
you think is gonna happen to that bond
price and you guessed it the bond price
went down below the par guy it's only
worth 864 dollars so you can see is
those interest rates rise on you if
you're buying a bond at a real low
interest rate and then interest rates
rise that bonds going to become
worthless and that's really important to
understand as you invest in bonds and
stocks you've got to be buying these
assets at the right time and how you can
buy these assets at the right time is
going back to the previous lesson lesson
3 where we learned about yield curves
and when you see that inverse yield
curve or that yield curve that's flat
that's the time to be in the bond market
because you're buying those bonds out of
high interest rate and the Federal
Reserve's showing you on the you
curb that they expect interest rates to
go down over a long period of time so
when you see that you're buying those
bonds at a high coupon with the
anticipation that the interest rates are
going to drop and you're gonna see a
change in your market pricing and it's
going to give you the capital that to
then take and invest in the stock market
when when stocks are really cheap so use
this tool to your advantage
put this put those coupon payments in
there see what that bond price would
would change to and really kind of learn
the ins and outs you don't have to
understand the calculation you just have
to understand how it changes with
interest rates and how it also changes
with the term so I hope that the
demonstration helps you understand how
bond prices move with interest rates
it's a very important concept to
understand and when you combine this
lesson with the previous lesson with the
yield curves I think you're gonna find
yourself really starting to understand
how these markets move and how the value
of these assets whether it's a bond or a
stock how they are interrelated and how
they all work together so go ahead and
play with the bond calculator really try
to understand that how the term affects
the bond and how the interest rates
effects the bond so this concludes
course to unit 2 lesson for calculating
the value of a bond you learn how the
price of the bond changes with interest
rates and you also learn how to use the
Buffett's books com bond calculator