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Market price

From Academic Kids

Market price is an economic concept with commonplace familiarity; it is the price that a good or service is offered at, or will fetch, in the marketplace; it is of interest mainly in the study of microeconomics.

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Other measures of value

Market price is one of a number of ways of establishing the monetary value of a transaction; there are others, such as historical cost; the resource cost of the good or service; the discounted present value, and others.

Classical economics

Many second order factors bear on market price in practise, not least the availability of market information to suppliers and potential purchasers.

In classical economics, the market price of a good or service is established in relation with demand, and in inverse relation with supply, which is to say the market price decreases as supply increases; increases as supply decreases; increases as demand increases; and decreases as demand decreases. The actual market price will establish a particular price point, valid for a short period which is the meshing of current demand and supply (see supply and demand).

Bonds

Market price has a slightly more specialised meaning in relation to bond trading. The price of a bond represents the present value of its anticipated future cash flows, the sum of the discounted values of periodic coupon payments and the principal amount over some holding period, usually to maturity.

The market price of a bond is commonly expressed in terms of $100 par value. A bond trading at $90, or below par, is said to be trading at a discount. A bond with a market price of $110, or above par, is said to be trading at a premium.

Bond prices are also expressed equivalently as a percentage yield. A bond trading to yield at the coupon rate is trading at par. Bonds trading below par yield higher than the coupon rate, while those trading at premium yield less than the coupon rate. Thus, price moves in the opposite direction of yield, and reflects a built-in capital gain or loss on the face value amount over the holding period.

In the case of a zero-coupon or strip bond, the market value is the discounted value of the coupon or residue, which likewise is expressed in terms of a maturity value of $100. A discount bond with a long term to maturity typically trade at a deep discount - for example less than $20.

If the maturity value of a strip bond is $10,000 and its current price is expressed as $20, the market value of the investment is $2,000. Similarly, if the price of a regular bond is $110 on a maturity value of $5,000, the market value of the bond is $5,500.

The price of a bond is affected by changes in interest rates and the credit worthiness of the issuer. The interest rate of a bond - also known as its nominal or coupon rate - is normally fixed. Consequently, changes to prevailing market rates -- interest rate risk -- can cause a bond to trade at a discount or premium. If market rates increase, the price of a bond declines. The price of a bond generally increases if market rates decline.

The discount rate on a bond normally takes into account prevailing market rates and the risk-characteristics of both the bond and its issuer. The issuer of a callable bond - which may be redeemed by the issuer prior to maturity - generally has to be offered at a higher yield to attract investors.

Government bonds, notably US Treasury issues, are generally considered risk-free. Since investors demand additional return for accepting the higher risk of corporate bonds, the yield spread above the risk-free rate is a meaningful measure of the risk of an instrument. Expressed as a dollar value, price above the equivalent Treasury issue is termed the risk premium.

See also

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