In fact, the bond price is a function of the combination of the coupon rate of interest and the yield of the bond. What do we mean by yield of the bond? It is the return that one would get on a similar bond of similar characteristics at the current point of time. At times the Yield may be lower than your coupon and at times the yield may be higher than your coupon bond. It is this relationship between the coupon rate and the yield that determines the price of the bond. After all, price of the bond is nothing but the present value of the future cash flows and these future cash flows are discounted by the yield.

As we saw earlier, the price of a bond is the present value of its promised cash flows. As an example, suppose that a bond has a face value of Rs.1,000, a coupon rate of 6% and a maturity of five years. The bond makes annual coupon payments. If the yield to maturity is 6%, the bond’s price will be very close to its face value as the rate at which the coupon pays you and the YTM snatches future value is almost compensated. That is how the price of bond is determined.