Bond Pricing and Inflation rates
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In bond pricing, the future cash flows are known. The amount and dates of interest and principle payments are known. The variable that remains unknown is the value of those flows. That can be determined through a number of different means, using a number of different assumptions
The simplest way to understand present value as applied to bond pricing is that the discount rate used to value the future cash flows is the rate at which we assume that each flow can be reinvested. This rate is not only going to be applied at some point in the future, but it will fluctuate for each flow. Those fluctuations occur as a result of changes in the prevailing interest rates. So what affects the prevailing interest rates? A number of factors do, but the government is a major influencer......
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