What method is used to price a bond?

The method utilized to price a bond predominantly involves discounting the future cash flows associated with the bond—namely, the periodic interest payments (coupons) and the principal amount to be repaid at maturity—back to their present value at the current interest rate. This approach is grounded in the time value of money principle, which acknowledges that a dollar received today is worth more than a dollar received in the future due to its potential earning capacity.

When calculating the price of a bond, the present value of these future cash flows is determined using the prevailing market interest rate. This ensures that the bond’s market price reflects the rate of return investors require for taking on the risk associated with that particular bond at the present time. As market interest rates fluctuate, this valuation method allows for the bond's price to adjust accordingly, making it a robust and widely accepted approach to bond pricing.

In contrast, other methods mentioned do not directly calculate the bond's current market value based on expected future cash flows and current interest rates, focusing instead on averages, historical data, or static values, none of which provide the dynamic assessment required for precise bond pricing today.