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Here's a small excerpt from Bond Valuation section on Investopedia:

Determining Whether a Bond Is Under or Over Valued What you need to be able to do is value a bond like we have done before using the more traditional method of applying one discount rate to the security. The twist here, however, is that instead of using one rate, you will use whatever rate the spot curve has that coordinates with the proper maturity. You will then add the values up as you did previously to get the value of the bond.

You will then be given a market price to compare to the value that you derived from your work. If the market price is above your figure, then the bond is undervalued and you should buy the issue. If the market price is below your price, then the bond is overvalued and you should sell the issue.

If the market price is above the bond value that you calculate then isn't the bond over-valued?? (literally speaking at least). Why would you want to buy the bond in this case when you know it is priced above its value?? I'm having some trouble understanding this concept

(I'm looking for an answer assuming the bonds are corporate bonds (if that makes any difference)

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    They've described a technique for determining the value of a bond. Once you've done that, if the market value is higher than the value that you calculated, the bond is overvalued. If the market value is lower, the bond is undervalued. – Pete Becker Sep 23 '15 at 19:06
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    What investopedia says is the opposite! So it's a mistake on the site? – Mathew Sep 26 '15 at 20:03
  • Yes, it looks to me like they got it upside down. – Pete Becker Sep 27 '15 at 2:41
  • Investopedia hasn't still updated this. Are we sure that it was a mistake on their part? – user42654 May 27 '16 at 9:38
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    It's definitely a mistake. If market price is above the fair value you calculate, it's overpriced. Basic stuff. Investopedia is not as heavily moderated/edited as are posts here. I am a mod and frequent poster here. It's fair to say I know my stuff. Fortunately, when I make an error, another member will set me right within minutes. The wisdom of crowds in action. Here. Not so much there. – JoeTaxpayer May 27 '16 at 12:11
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+50

If the market price is above the bond value that you calculate then isn't the bond over-valued?? (literally speaking at least).

Yes. It indicates the demand for the bonds is greater than the supply, and that the market is willing to pay a higher price for them.

Why would you want to buy the bond in this case when you know it is priced above its value?? I'm having some trouble understanding this concept

From a bond standpoint it could be if the market things the bond has more value than the analysis. Maybe everyone expects Moody's to upgrade the company's credit rating (so would you a lower risk value), or the company is about to get a backstop from the government. Maybe interest rates are about to plummet.

  • @prr corrected - demand would be greater than supply – xirt Apr 10 '18 at 11:18

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