Valuing Fixed-Income Securities

The most well-known measure to determine the value of fixed income securities is the discounted cash flow (DCF) model. The discounted cash flow model calculates the present value of all the future cash flows of a fixed income investment. This would include every interest payment received, as well as the return of the original principal invested, which is usually the face value of the security. The present value of each payment is calculated using the present value formula:

For example, if a $1,000 bond could be purchased today that would pay $25 every six months for the next ten years, as well as return the original $1,000 ten years from now, the discounted cash flow model would calculate the present value of each one of these future amounts.

Once all present values of all the payments are calculated, they’re added to arrive at a total discounted cash flow for the future of the security. If this total is greater than the current price of the bond or fixed income security, it would be considered a good deal and should be bought. This conclusion is based on the belief that the investor is essentially buying the right to the future ca