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PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
BOND VALUATION
Q1
Value of bond or current market price of bond is present value of all future cash outflows of the
bond at Expected rate of return or cost of capital. It is also known as Intrinsic value or equilibrium
price.
Value of the bond
=
P.V of all cash outflow
Current market price
=
P.V of Interest at 12%
+
=
80 x 4.96
+
1100 x 0.403
=
396.8
+
443.3
=
840.71
P.V of redeemable
amount of bond @ 12%
Value of Bond if Interest is paid semiannually
Value of the bond
=
P.V of all cash outflow
Current market price
=
P.V of Interest at 6%
For 16 yrs
+
P.V of redeemable
amount of bond @ 6% for 16 years
=
40 x 10.106
+
1100 x 0.394
=
404.24
+
433.4
=
837.64
Value of Bond if Interest is paid semiannually and Expected rate of return is 6%
Value of the bond
=
P.V of all cash outflow
Current market price
=
P.V of Interest at 3%
For 16 yrs
+
P.V of redeemable
amount of bond @ 3% for 16 years
=
40 x 12.561
+
1100 x 0.623
=
502.44
+
685.3
1
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
Q2
Q3
Q4
Value of bond or current market price of bond is present value of all future cash outflows of the bond
at Expected rate of return or cost of capital. It is also known as Intrinsic value or equilibrium price.
Value of the bond
=
P.V of all cash outflow
Current market price
=
P.V of Interest at 10%
+
P.V of redeemable
amount of bond @ 10%
=
90 x 3.791
+
1,000 x 0.621
=
341.19
+
621
=
962.19
Value of bond or current market price of bond is present value of all future cash outflows of the bond
at Expected rate of return or cost of capital. It is also known as Intrinsic value or equilibrium price.
Value of the bond
=
P.V of all cash outflow
Current market price
=
P.V of Interest at 8%
+
P.V of redeemable
amount of bond @ 8%
=
70 x 7.536
+
1000 x 0.397
=
527.25
+
397
=
924.525
Value of bond or current market price of bond is present value of all future cash outflows of the bond
at Expected rate of return or cost of capital. It is also known as Intrinsic value or equilibrium price.
Value of the bond
=
P.V of all cash outflow
Statement of cash outflows
Year
Principal paid
Every year
Interest
1
2
3
4
5
6
7
8
125
100
225
125
87.50
212.50
125
75.00
200
125
62.50
187.50
125
50.00
175.00
125
37.50
162.50
125
25
150.00
125
12.50
137.50
Present value of future cash outflows or value of bond
2
total cash
outflow
Discounting
factor @ 8%
0.926
0.857
0.794
0.735
0.681
0.630
0.583
0.540
Present
value of
Cash
outflow
208.35
182.11
158.80
137.81
119.18
102.38
87.45
74.25
1070.33
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
Q5
Value of bond or current market price of bond is present value of all future cash outflows of the bond
at Expected rate of return or cost of capital. It is also known as Intrinsic value or equilibrium price.
Value of the bond
=
P.V of all cash outflow
Statement of present value of Cash outflows
Q6
Year
Principal paid
Every year
15
6
7
8
9
10
115
115
3.517
230
115
345
0.480
230
92
322
0.425
230
69
299
0.376
230
46
276
0.333
230
23
253
0.295
Present value of Future cash outflows or Current market price of bond
total cash
outflow
Discounting
factor @ 13%
Present
value of
Cash
Outflows
404.46
165.60
136.85
112.42
91.91
74.64
985.88
Value of bond or current market price of bond is present value of all future cash outflows of the bond
at Expected rate of return or cost of capital. It is also known as Intrinsic value or equilibrium price.
Value of the bond
=
P.V of all cash outflow
Current market price
=
P.V of Interest at 16%
=
P.V of redeemable
amount of bond @ 16%
(9 x 2.798) + (10 x 2.798 x 0.552) + (14 x 1.605 x 0.305) + (105 x 0.226)
=
=
Q7
Interest
+
25.182 + 15.44496 + 6.85335 + 23.73
71.21
Value of bond or current market price of bond is present value of all future cash outflows of the bond
at Expected rate of return or cost of capital. It is also known as Intrinsic value or equilibrium price.
Value of the bond
=
P.V of all cash outflow
=
= Rs 1,600
Price of the bond if yield is 9%
=
= Rs 2,667
3
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
b.
Current yield is the return of the bond at the current market price
Current yield
=
0.10
=
=
Rs 900
If current Yield is 8%
= Rs 1125
CMP =
If current yield is 12%
= Rs 750
CMP =
Q8
Value of bond or current market price of bond is present value of all future cash outflows of the bond
at Expected rate of return or cost of capital. It is also known as Intrinsic value or equilibrium price.
Value of the bond
=
P.V of all cash outflow
Equilibrium market price =
Or Intrinsic value
P.V of Interest at 11%
+
P.V of redeemable
amount of bond @ 11%
=
40 x 3.695
+
500 x 0.593
=
147.8
+
296.7
=
444.52
Bond is currently traded at 95% i.e (500 x 0.95) Rs 475.
Since actual market price is more than Intrinsic value, So bond is overpriced. Thus bond is not a
desirable Investment.
Q9
Value of bond or current market price of bond is present value of all future cash outflows of the bond
at Expected rate of return or cost of capital. It is also known as Intrinsic value or equilibrium price.
Value of the bond
=
P.V of all cash outflow
Current market price
=
P.V of Interest at 10%
For 5 years
=
(8 x 1.735) + (10 x 2.486 x 0.826) + 102 x 0.620
=
13.88
+
+
20.534 +
P.V of redeemable
amount of bond @ 10%
For 5 years
63.24
=
97.654
Equilibrium price or Intrinsic value of the bond is Rs 97.654. If this bond is available at Rs 94, Mr X
should purchase this bond.
4
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
Q10
Q11
A bond with face value of Rs 500 will be matured after 15 years at a premium of 5%.
th
Interest is paid semiannually @ 12%p.a from 6 year
Value of bond or current market price of bond is present value of all future cash outflows of the bond
at Expected rate of return or cost of capital. It is also known as Intrinsic value or equilibrium price.
Value of the bond
=
P.V of all cash outflow
Current market price
=
P.V of Interest at 10%
For 15 years
+
=
=
=
30 x 12.462 x 0.6139
229.513
350.9455
+
+
P.V of redeemable
amount of bond @ 10%
For 15 years
525 x 0.2313
121.4325
Bond is convertible into 5 equity shares after 5 years.
Current market price of share is Rs 22 which is expected to increase @ 5% p.a
5
Market price of share after 5 years =
22 (1.05) = 22 x 1.276 = 28.072
Redeemable value of bond is Value of 5 shares after 5 years
= 5 x 28.072 = Rs 140.36
Value of bond or current market price of bond is present value of all future cash outflows of the
bond at Expected rate of return or cost of capital. It is also known as Intrinsic value or equilibrium
price.
Value of the bond
=
P.V of all cash outflow
Current market price
Q12
=
P.V of Interest at 8%
For 5 years
+
P.V of redeemable
amount of bond @ 8%
=
11 x 3.993
+
140.36 x 0.681
=
43.923
+
95.585
=
Rs 139.508
Current market price of bond is present value of all future cash outflows at expected rate of
return.
Debenture holder has the option to convert debenture into 20 equity shares till maturity. Holder
will exercise the option of conversion when value of shares received is equal to or more than
value of debenture
Value of the Debenture =
P.V of all cash outflow
Current market price
=
P.V of Interest at 8%
For 5 years
+
P.V of redeemable
amount of bond @ 8%
=
12 x 3.993
+
100 x 0.681
=
47.916
+
68.1
=
116.016
5
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
Statement of value of share at given market price
If Market price of share is Rs 4 =
If Market price of share is Rs 5 =
If Market price of share is Rs 6 =
Total value of 20 shares Rs 80
Total value of 20 shares Rs 100
Total value of 20 shares Rs 120
Thus debenture holder will exercise the option of conversion only if Market price of share is Rs 6,
as the value of his shareholding will be more than value of debenture holdings if the price is Rs 6
or more.
Q13
Assuming current value of the bond is 1, the period required to double the value at compounding
of 9% is
x
1 . (1.09) = 2
Taking log on both sides
x log 1.09 = log 2
x X 0.374 = 3.010
x = 8.05 years
the period required to triple the value at compounding rate of 9% is
x
1 . (1.09) = 3
x log 1.09 = log 3
x (0.374) = 4.771
x=
Q14
= 12.757 years
Current value of the bond is present value of all future outflows. In case of Zero coupon bond,
outflow will be of face value, on the maturity i.e there will be no intermediate outflows in form of
interest during the life of bond.
Current market price
=
Present value of all future outflows
=
1,00,000 x 0.593
=
Rs 59,300
If currently bond is traded at Rs 74,700, the it is overpriced bond as equilibrium price of the bond
is less than actual price of the bond. In this case if investor is holding the bond, he should sell it. If
investor is not holding the bond, he should not buy it.
Expected or equilibrium price of the bond is the present value of the outflows of the bond at
expected rate of return. Higher the expected rate of return lower will be the expected or
equilibrium price.
If actual market price is higher, this implies that actual rate of return of bond is lower than
expected rate of return. In this case investor should dispose such existing bond or should not
invest in such bond
If actual market price is lower than equilibrium market price, this implies that actual rate of return
is more than expected rate of return, in this case investor should hold or purchase the bond.
6
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
Q15
Q16
Current market price
a.
=
Present value of all future outflows
=
25,000 x 0.226
=
5,650
face value of bond is Rs 100 and discount yield is 6 %
Discount = 100 x .06 x
= 0.75
Current market price = 100 – 0.75 = Rs 99.25
b.
Bond equivalent yield = 0.75 is the return for 45 days on the investment of Rs 99.25. yield
for full year is
x 360
c.
effective annual rate of return = (value of 1 Re invested for a year with compounding
after 45 days)
(1+
Q17
a.
= 6.045 % p.a
x
=
1.0621
=
6.21% p.a
Holding period rate of return =
x 100
x 100
=
=
43.75%
If bond is sold for Rs 750 after receiving interest of Rs 150, then holding period rate of
return is
x 100
x 100
=
=
12.5%
7
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
b.
Holding period rate of return =
x 100
x 100
=
=
12.85 %
Value of return = 120 + (995 – 988) = Rs 127
Real return if average inflation rate is 4.49%
or
12.85% of 988 = 127
( 1 + Nominal rate ) = ( 1 + Real rate ) ( 1 + Inflation rate)
Real rate
=
=
 1
8%
Value of return = 998 X 8% = Rs 79.04
Q18
Current yield
=
=
Q19
=
12.5%
YTM is the rate of return on bond if it is purchased at current market price and held till the date of
maturity. It is the rate at which present value of cash outflows of the bond is equal to present value
of cash inflows or current market price of the bond.
Approximate YTM
=
=
= 9.87 %
YTM of bond
Present value of cash outflows at 9%
=
=
=
=
P.V of interest @ 9% for 5 years
80 x 3.890
311.20
961.20
8
+
+
+
P.V of redeemable value @ 9%
1000 x 0.650
650
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
Present value of Cash outflow at 10%
=
=
=
=
P.V of interest @ 10% for 5 years
80 x 3.791
303.28
924.28
+
+
+
P.V of redeemable value @ 10%
1,000 x 0.621
621
YTM is the rate at which present value of cash outflow is equal to present value of cash inflows
i.e present value of cash outflow = Rs 925
For Present value of cash outflow of 961.20
For Present value of cash outflow of 924.28
For present value of cash outflow of 925 , rate is
=
9%
=
9.98%
+
Rate is 9%
Rate is 10%
961.20 ………. 9%
925
?
924.28 …………. 10%
x1
For change in PV of (961.20 – 924.28)
36.92 change in rate is 1%.
For change in PV of (961.20 – 925) 36.2
Change in rate (from 9%) is
9%
Q20
Current yield
+
x1
=
=
x 100
=
11.60%
YTM is the rate of return on bond if it is purchased at current market price and held till the date of
maturity. It is the rate at which present value of cash outflows of the bond is equal to present value
of cash inflows or current market price of the bond.
Approximate YTM
=
=
= 10 %
YTM of bond
Present value of cash outflows at 9%
=
=
=
P.V of interest @ 9% for 5 years
13 x 3.890
50.57
=
115.57
9
+
+
+
P.V of redeemable value @ 9%
100 x 0.650
65
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
Present value of Cash outflow at 11%
=
=
=
=
P.V of interest @ 11% for 5 years
13 x 3.696
48.048
107.348
+
+
+
P.V of redeemable value @ 11%
100 x 0.593
59.3
YTM is the rate at which present value of cash outflow is equal to present value of cash inflows
i.e present value of cash outflow = Rs 112
For Present value of cash outflow of 115.57
For Present value of cash outflow of 107.348
Rate is 9%
Rate is 11%
For present value of cash outflow of 112 , rate is
=
9%
+
=
9.868%
115.57 ………. 9%
112
?
107.348 ………….11%
x2
For change in PV of (115.57 – 107.348)
8.222 change in rate is 2%.
For change in PV of (115.57  112) 3.57
Change in rate (from 9%) is
9%
Q21
+
x2
Value of bond or current market price of bond is present value of all future cash outflows of the
bond at Expected rate of return or cost of capital. It is also known as Intrinsic value or equilibrium
price.
Value of the bond
=
P.V of all cash outflow
Current market price
=
P.V of Interest at 13%
For 3 years
+
=
=
=
11 x 2.361
25.971
95.271
+
+
P.V of redeemable
amount of bond @ 13%
rd
For 3 year
100 x 0.693
69.3
YTM is the rate of return on bond if it is purchased at current market price and held till the date of
maturity. It is the rate at which present value of cash outflows of the bond is equal to present value
of cash inflows or current market price of the bond.
Approximate YTM
=
10
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
=
= 11.94 %
YTM of bond
Present value of Cash outflow at 11%
=
=
=
=
P.V of interest @ 11% for 3 years
11 x 2.444
26.884
99.984
+
+
+
P.V of redeemable value @ 11%
100 x 0.731
73.1
Present value of cash outflows at 13%
=
=
=
=
P.V of interest @ 13% for 3 years
11 x 2.361
25.971
95.271
+
+
+
P.V of redeemable value @ 13%
100 x 0.693
69.3
YTM is the rate at which present value of cash outflow is equal to present value of cash inflows
i.e present value of cash outflow = Rs 97.60
For Present value of cash outflow of 99.984
For Present value of cash outflow of 95.271
Rate is 11%
Rate is 13%
For present value of cash outflow of 97.60 , rate is
=
11 %
=
12.012
+
99.984 ………. 11%
97.60
?
95.271 …………. 13%
x2
For change in PV of (99.984 – 95.271)
4.713 change in rate is 2%.
For change in PV of (99.984 – 97.60) 2.384
Change in rate (from 11%) is
11 %
Q22
+
x2
Value of bond or current market price of bond is present value of all future cash outflows of the
bond at Expected rate of return or cost of capital. It is also known as Intrinsic value or equilibrium
price.
Value of the bond
=
P.V of all cash outflow
Current market price
=
P.V of Interest at 10% +
P.V of redeemable
For 4 years
amount of bond @ 10%
th
For 4 year
=
800 x 3.170
+
10000 x 0.683
=
2536
+
6830
=
9366
11
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
YTM is the rate of return on bond if it is purchased at current market price and held till the date of
maturity. It is the rate at which present value of cash outflows of the bond is equal to present value
of cash inflows or current market price of the bond.
Approximate YTM
=
=
= 11.75 %
YTM of bond
Present value of Cash outflow at 11%
=
=
=
=
P.V of interest @ 11% for 4 years
800 x 3.102
2481.6
9071.6
+
+
+
P.V of redeemable value @ 11%
10000 x 0.659
6590
Present value of cash outflows at 12%
=
=
=
=
P.V of interest @ 12% for 4 years
800 x 3.037
2429.6
8789.6
+
+
+
P.V of redeemable value @ 12%
10000 x 0.636
6360
YTM is the rate at which present value of cash outflow is equal to present value of cash inflows
i.e present value of cash outflow = Rs 97.60
For Present value of cash outflow of 9071.6
For Present value of cash outflow of 8789.6
Rate is 11%
Rate is 12%
For present value of cash outflow of 8785.07, rate is
=
11 %
=
12.016
+
9071.6 ………. 11%
8789.6 …………. 12%
8785.07
?
x1
The rate at which present value of outflow of bond
Is equal to current market price is 12.016% .
Required rate of return is 10%.
Since return from bond is higher than required rate
Of return, so investor should purchase the bond.
12
For change in PV of (9071.6 – 8789.6) 282
change in rate is 1%.
For change in PV of (9071.6 – 8785.07)
286.53 Change in rate (from 11%) is
11 %
+
x1
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
Q23
YTM is the rate of return on bond if it is purchased at current market price and held till the date of
maturity. It is the rate at which present value of cash outflows of the bond is equal to present
value of cash inflows or current market price of the bond.
Statement of present value of cash outflows
Year
1
2
3
4
5
6
7
8
9
10
cash outflow
70
70
70
70
70
70
70
70 + 500
70
70 + 500
PV factor 5%
.952
.907
.864
.823
.784
.746
.711
.676
.644
.614
Present value
66.64
63.49
60.48
57.61
54.88
52.22
49.77
385.32
45.08
349.98
1185.47
Factor 8%
0.926
0.857
0.794
0.735
0.681
0.630
0.583
0.540
0.500
0.463
Present value
64.82
59.99
55.58
51.45
47.67
44.10
40.81
307.8
35
263.91
971.13
YTM is the rate at which present value of cash outflow is equal to present value of cash inflows
i.e present value of cash outflow = Rs 1062
For Present value of cash outflow of 1185.47
For Present value of cash outflow of 971.13
Rate is 5%
Rate is 8%
For present value of cash outflow of 1062, rate is
YTM
=
5%
=
6.73 %
=
=
+
1185.47………. 5%
1062 ………. ?
971.13 …………. 8%
x3
For change in PV of (1185.47 – 971.13)
214.34 change in rate is 3%.
6.73 x 2
13.46 % p.a
For change in PV of (1185.47  1062)
123.47 Change in rate (from 5%) is
5%
b.
+
x3
Effect on price of bond, if YTM increases by 2% i.e if YTM is 15.46%
YTM for 6 months is
= 7.73
For 3% change in rate, change in price is 214.34, For (7.73 – 5) i.e 2.73% change in rate change
in price is
x 214.34 = 195.0494
New price
= 1185.47 – 195.0494
= 990.4206
13
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
Q24
YTM is the rate of return on bond if it is purchased at current market price and held till the date of
maturity. It is the rate at which present value of cash outflows of the bond is equal to present value
of cash inflows or current market price of the bond.
Approximate YTM
=
=
= 16.544 %
YTM of bond
Present value of Cash outflow at 16%
=
=
=
=
P.V of interest @ 16% for 5 years
70 x 3.274
229.18
467.18
+
+
+
P.V of redeemable value @ 16%
500 x 0.476
238
Present value of cash outflows at 17%
=
=
=
=
P.V of interest @ 17% for 5 years
70 x 3.199
223.93
451.93
+
+
+
P.V of redeemable value @ 17%
500 x 0.456
228
YTM is the rate at which present value of cash outflow is equal to present value of cash inflows
i.e present value of cash outflow = Rs 455
For Present value of cash outflow of 467.18
For Present value of cash outflow of 451.93
Rate is 16%
Rate is 17%
For present value of cash outflow of 455 , rate is
=
16 %
+
=
16.80 %
467.18 ………. 16%
455
?
451.93 …………. 17%
x1
For change in PV of (467.18 – 451.93)
15.25 change in rate is 1%.
For change in PV of (467.18  455) 12.18
Change in rate (from 16%) is
16 %
+
x1
Change in market price If YTM decreases by 10% i.e if YTM is 6.8%
For 1% change in YTM, change in price is 15.25. For 10% decrease in YTM, change in price is
x 10 = 152.5
New price
= 455 + 152.5
= 607.5
14
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
Q25
YTM is the rate of return on bond if it is purchased at current market price and held till the date of
maturity. It is the rate at which present value of cash outflows of the bond is equal to present value
of cash inflows or current market price of the bond.
Approximate YTM
=
=
= 17.30 %
YTM of bond
Present value of Cash outflow at 17%
=
P.V of interest @ 17% for 2 years
=
100 x 1.585
=
158.5
=
889.5
Present value of cash outflows at 18%
+
+
+
P.V of redeemable value @ 17%
1000 x 0.731
731
=
P.V of interest @ 18% for 2 years
+
P.V of redeemable value @ 18%
=
100 x 1.566
+
1000 x 0.718
=
156.6
+
718
=
874.6
YTM is the rate at which present value of cash outflow is equal to present value of cash inflows
i.e present value of cash outflow = Rs 874.75
For Present value of cash outflow of 889.5
Rate is 17%
For Present value of cash outflow of 874.6
Rate is 18%
For present value of cash outflow of 874.75 , rate is
=
17 %
=
17.99%
+
889.5 ………. 17%
874.75
?
874.6 …………. 18%
x1
For change in PV of (889.5 – 874.6) 14.9
change in rate is 1%.
For change in PV of (889.5 – 874.75) 14.75
Change in rate (from 17%) is
17 %
+
x1
New YTM if Market price increases to 1035.66
For increase in price of 14.9 fall in YTM is 1% , for increase in price of (1035.66 – 874.75) 160.91
fall in rate is
=
New YTM
x1
=
10.80
= 17.99 – 10.80
= 7.19
15
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
Q26
YTM is the rate of return on bond if it is purchased at current market price and held till the date of
maturity. It is the rate at which present value of cash outflows of the bond is equal to present value
of cash inflows or current market price of the bond.
Approximate YTM
=
=
= 7.08 % semi annually
i.e 7.08 x 2 = 14.16% p.a
YTM of bond
Present value of Cash outflow at 7%
=
=
=
=
P.V of interest @ 7% for 8 years +
50 x 5.971
298.55
880.55
P.V of redeemable value @ 7%
+
1000 x 0.582
+
582
Present value of cash outflows at 8%
=
=
=
=
P.V of interest @ 8% for 8 years +
50 x 5.747
287.35
827.35
P.V of redeemable value @ 8%
+
1000 x 0.540
+
540
YTM is the rate at which present value of cash outflow is equal to present value of cash inflows
i.e present value of cash outflow = Rs 870
For Present value of cash outflow of 880.55
For Present value of cash outflow of 827.35
Rate is 7%
Rate is 8%
For present value of cash outflow of 870 , rate is
=
7%
+
=
=
=
7.20% semiannually
7.20 x 2
14.40 p.a
880.55 ………. 7%
870
?
827.35 …………. 8%
x1
For change in PV of (880.55 – 827.35) 53.2
change in rate is 1%.
YTM of bond is 14.40% and his required rate of
return is 21%, so investor will not purchase the
bond.
16
For change in PV of (880.55  870) 10.55
Change in rate (from 7%) is
7%
+
x1
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
Q27
YTM is the rate of return on bond if it is purchased at current market price and held till the date of
maturity. It is the rate at which present value of cash outflows of the bond is equal to present value
of cash inflows or current market price of the bond.
Approximate YTM
=
=
= 5 % semi annually
i.e 5 x 2 = 10% p.a
YTM of bond
Present value of Cash outflow at 9%
=
=
=
=
P.V of interest @ 4% for 30 years
50 x 17.292
864.6
1172.6
+
+
+
P.V of redeemable value @ 4%
1000 x 0.308
308
Present value of cash outflows at 6%
=
=
=
=
P.V of interest @ 6% for 30 years
50 x 13.765
688.25
862.25
+
+
+
P.V of redeemable value @ 6%
1000 x 0.174
174
YTM is the rate at which present value of cash outflow is equal to present value of cash inflows
i.e present value of cash outflow = Rs 1000
For Present value of cash outflow of 1172.6
For Present value of cash outflow of 862.25
Rate is 4%
Rate is 6%
For present value of cash outflow of 1000 , rate is
=
4%
+
=
=
=
5.112 % semi annually
5.112 x 2
10.224 p.a
1172.6 ………. 4%
1000
?
862.25 …………. 6%
x1
For change in PV of (1172.6 – 862.25)
310.35 change in rate is 2%.
For change in PV of (1172.6 – 1000) 172.6
Change in rate (from 4%) is
4%
17
+
x2
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
b.
Value of bond or current market price of bond is present value of all future cash outflows of the
bond at Expected rate of return or cost of capital. It is also known as Intrinsic value or equilibrium
price.
Value of the bond
=
P.V of all cash outflow
st
=
Price on 1 Jan 08 + Accrued Interest till 31 Mar 08
=
50 x 10.105 + 1000 x 0.396
=
917.964
MP on 1 March 08
Q28
st
st
+ 50 x
Value of bond or current market price of bond is present value of all future cash outflows of the
bond at Expected rate of return or cost of capital. It is also known as Intrinsic value or equilibrium
price.
Value of the bond
=
P.V of all cash outflow
Current market price
=
i.e price as on 1.04.03
P.V of Interest at 18%
+
P.V of redeemable
amount of bond @ 18%
=
15 x 3.127
+
125 x 0.437
=
101.525
P.V of Interest at 18%
+
P.V of redeemable
amount of bond @ 18%
15 x 2.690
104.725
+
125 x 0.515
P.V of Interest at 18%
+
P.V of redeemable
amount of bond @ 18%
15 x 2.17
108.55
+
125 x 0.608
P.V of Interest at 18%
+
P.V of redeemable
amount of bond @ 18%
15 x 1.565
113.225
+
125 x .718
P.V of Interest at 18%
+
15 x 0.847
118.58
+
P.V of redeemable
amount of bond @ 18%
125 x 0.847
Current market price
=
i.e price as on 1.04.04
=
=
Current market price
=
i.e price as on 1.04.05
=
=
Current market price
=
i.e price as on 1.04.06
=
=
Current market price
=
i.e price as on 1.04.07
=
=
18
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
Q29
Capital gain on bond
=
=
=
Capital Gain (after tax) =
=
Redeemable value  Issue price
105  90
15
15 (1  .10)
13.5
Issue Price of the bond =
Discount on issue
=
90
10%
= 100
Face value of the bond =
Interest on Bond @ 9% =
Tax on Interest
=
Interest after tax
=
Approximate YTM
Rs 9
30%
9 ( 1 – 0.3)
=
6.3
=
9.3%
=
=
YTM of bond
Present value of Cash outflow at 9%
=
P.V of interest @ 9%
+
P.V of redeemable value @ 9%
=
6.3 x 3.88
+
103.5 x 0.649
=
24.50
+
67.17
=
91.67
Present value of cash outflows at 10%
=
P.V of interest @ 10% +
P.V of redeemable value @ 10%
=
6.3 x 3.790
+
103.5 x 0.620
=
23.877
+
64.17
=
88.047
YTM is the rate at which present value of cash outflow is equal to present value of cash inflows
i.e present value of cash outflow = Rs 90
For Present value of cash outflow of 91.67
Rate is 9%
For Present value of cash outflow of 88.047
Rate is 10%
91.67 ………. 9%
90
?
88.047 …………. 10%
For present value of cash outflow of 1000 , rate is
=
=
9%
+
x1
For change in PV of (91.67 – 88.047) 3.623
change in rate is 1%.
9.461%
For change in PV of (91.67 – 90) 1.67
Change in rate (from 9%) is
9%
19
+
x1
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
Q30
Value of bond or current market price of bond is present value of all future cash outflows of the
bond at Expected rate of return or cost of capital. It is also known as Intrinsic value or equilibrium
price.
Value of the bond
=
P.V of all cash outflow
Current market price
=
P.V of Interest at 7%
For 10 years
+
=
=
=
80 x 7.024
561.92
1069.92
+
+
P.V of redeemable
th
amount of bond @ 7% for 10 year
1,000 x 0.508
508
Since Intrinsic value of Rs 1069.92 is more than its current Market price of rs 1040, the bond
must be held or purchased by the Investor.
YTM is the rate of return on bond if it is purchased at current market price and held till the date of
maturity. It is the rate at which present value of cash outflows of the bond is equal to present value
of cash inflows or current market price of the bond.
Approximate YTM
=
=
= 7.45 % Semi annually
i.e 7.45 x 2 = 14.90%
YTM of bond
Present value of Cash outflow at 7%
=
=
=
=
P.V of interest @ 7% for 10 years
80 x 7.024
561.92
1069.92
+
+
+
P.V of redeemable value @ 7%
1000 x 0.508
508
Present value of cash outflows at 8%
=
=
=
=
P.V of interest @ 8% for 10 years
80 x 6.710
536.80
999.8
+
+
+
P.V of redeemable value @ 8%
1000 x 0.463
463
YTM is the rate at which present value of cash outflow is equal to present value of cash inflows
i.e present value of cash outflow = Rs 1000
20
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
For Present value of cash outflow of 1069.92
For Present value of cash outflow of 999.80
Rate is 7%
Rate is 8%
For present value of cash outflow of 1040 , rate is
=
7%
+
x1
=
=
7.427 % semi annually
i.e 7.427 x 2 = 14.854% p.a
1069.92 ………. 7%
1040
?
999.80 ………….
8%
For change in PV of (1069.92 – 999.80) 70.12
change in rate is 1%.
For change in PV of (1069.92 – 1040) 29.92
Change in rate (from 7%) is
7%
Q31
+
x1
Z is considering investment in AA rated bonds.
Discount rate of AA rated bond =
=
=
=
Current market price of bond is =
Rate of Interest
=
AAA + 2 % spread
364 T bill + 3% spread + 2% spread
9% + 3% + 2%
14%
1025
15%
Value of bond or current market price of bond is present value of all future cash outflows of the
bond at Expected rate of return or cost of capital. It is also known as Intrinsic value or equilibrium
price.
Value of the bond
=
P.V of all cash outflow
Current market price
=
P.V of Interest at 14%
For 5 years
+
=
=
=
150 x 3.433
514.95
1033.95
+
+
P.V of redeemable
th
amount of bond @ 14% for 5 year
1000 x 0.519
519
Intrinsic value of the bond is more than current market price, investor should buy this bond.
21
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
Current yield of the bond is interest earned on Bond on its current market price
Current Yield
=
=
=
14.62%
YTM is the rate of return on bond if it is purchased at current market price and held till the date of
maturity. It is the rate at which present value of cash outflows of the bond is equal to present value
of cash inflows or current market price of the bond.
Approximate YTM
=
=
= 14.29%
YTM of bond
Present value of Cash outflow at 14%
=
=
=
=
P.V of interest @ 14% for 5 years
150 x 3.433
514.95
1033.95
+
+
+
P.V of redeemable value @ 14%
1000 x 0.519
519
Present value of cash outflows at 15%
=
=
=
=
P.V of interest @ 15% for 5 years
150 x 3.352
502.8
999.8
+
+
+
P.V of redeemable value @ 15%
1000 x 0.497
497
YTM is the rate at which present value of cash outflow is equal to present value of cash inflows
i.e present value of cash outflow = Rs 1025.86
For Present value of cash outflow of 1033.95
For Present value of cash outflow of 999.8
22
Rate is 14%
Rate is 15%
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
For present value of cash outflow of 1025.86 , rate is
=
=
14%
+
1033.95 ………. 14%
1025.86
?
999.80 …………. 15%
x1
14.237%
For change in PV of (1033.95 – 999.80) 34.15
change in rate is 1%.
For change in PV of (1033.95 – 1025.86) 8.09
Change in rate (from 14%) is
14%
Q32
+
x1
YTM is the rate of return on bond if it is purchased at current market price and held till the date of
maturity. It is the rate at which present value of cash outflows of the bond is equal to present value of
cash inflows or current market price of the bond.
For first two years X received Interest @ 10% on face value of Rs 1,000 and for next 3 years X
received Interest @ 7% on face value of Rs 1,000 after which X received redeemable value of Rs
1,000.
Present value of cash outflows at 8%
Years
1
2
3
4
5
Amount
100
100
70
70
1070
Factor
0.925
0.857
0.793
0.735
0.680
Present value
92.5
85.7
55.51
51.45
728.22
1013.18
At 8% Present value of cash flows is more than current market price of Rs 1,000. Thus YTM is more
than 8%
Present value of cash outflows at 10%
Years
1
2
3
4
5
Amount
100
100
70
70
1070
Factor
0.909
0.826
0.751
0.683
0.620
Present value
90.9
82.6
52.57
47.81
663.4
937.28
At 10% Present value of cash flows is less than current market price of Rs 1,000. Thus YTM is less
than 10%
YTM is Between 8% and 10%
23
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
For Present value of cash outflow of 1013.18
For Present value of cash outflow of 937.28
Rate is 8%
Rate is 10%
1013.18 ………. 8%
1000
?
937.28 …………. 10%
For present value of cash outflow of 1000 , rate is
=
8%
=
+
x2
For change in PV of (1033.95 – 999.80) 75.9
change in rate is 2%.
8.347%
For change in PV of (1013.18  1000) 13.18
Change in rate (from 8%) is
8%
Q33
+
x2
YTC is the rate at which present value of cash outflows till the date of call of the bond is equal to
present value of cash inflows or current market price of the bond.
Approximate YTM
=
=
= 10.37%
YTM of bond
Present value of Cash outflow at 10%
=
=
=
=
P.V of interest @ 10% for 2 years
12 x 1.736
20.832
107.562
+
+
+
P.V of redeemable value @ 14%
105 x 0.826
86.73
Present value of cash outflows at 11%
=
=
=
=
P.V of interest @ 11% for 2 years
12 x 1.713
20.556
105.816
+
+
+
P.V of redeemable value @ 11%
105 x 0.812
85.26
YTM is the rate at which present value of cash outflow is equal to present value of cash inflows
i.e present value of cash outflow = Rs 107
For Present value of cash outflow of 107.562
For Present value of cash outflow of 105.816
24
Rate is 10%
Rate is 11%
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
For present value of cash outflow of 107 , rate is
=
10%
=
10.322
+
107.562 ………. 10%
107
?
105.816 …………. 11%
x1
For change in PV of (107.562 – 105.816) 1.746
change in rate is 1%.
For change in PV of (107.562 – 107) 0.562
Change in rate (from 10%) is
+
10%
Q34
x1
YTM is the rate of return on bond if it is purchased at current market price and held till the date of
maturity. It is the rate at which present value of cash outflows of the bond is equal to present value of
cash inflows or current market price of the bond.
Approximate YTM
=
=
= 9.043%
YTM of bond
Present value of Cash outflow at 8%
=
=
=
=
P.V of interest @ 8% for 4 years
100 x 3.312
331.20
1066.20
+
+
+
P.V of redeemable value @ 8%
1000 x 0.735
735
Present value of cash outflows at 10%
=
=
=
=
P.V of interest @ 10% for 4 years
100 x 3.170
317
1000
+
+
+
P.V of redeemable value @ 10%
1000 x 0.683
683
YTM is the rate at which present value of cash outflow is equal to present value of cash inflows
i.e present value of cash outflow = Rs 1032.40
For Present value of cash outflow of 1066.20
For Present value of cash outflow of 1000
25
Rate is 8%
Rate is 10%
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
For present value of cash outflow of 1032.4 , rate is
=
8%
=
+
1066.20 ……….
8%
1032.40
?
1000
…………. 10%
x2
9.021 %
For change in PV of (1066.20 – 1000) 66.20
change in rate is 2%.
For change in PV of (1066.20 – 1032.40) 33.80
Change in rate (from 8%) is
8%
+
x2
YTC is the rate at which present value of cash outflows of the bond till the date of call is equal to
present value of cash inflows or current market price of the bond.
Approximate YTM
=
=
= 12.55%
YTC of bond
Present value of Cash outflow at 12%
=
=
=
=
P.V of interest @ 12% for 2 years
100 x 1.690
169
1045.7
+
+
+
P.V of redeemable value @12%
1100 x 0.797
876.7
Present value of cash outflows at 13%
=
=
=
=
P.V of interest @ 13% for 2 years
100 x 1.668
166.8
1028.1
+
+
+
P.V of redeemable value @ 13%
1100 x 0.783
861.3
YTC is the rate at which present value of cash outflow is equal to present value of cash inflows i.e
present value of cash outflow = Rs 1032.40
For Present value of cash outflow of 1045.7
For Present value of cash outflow of 1028.1
26
Rate is 12%
Rate is 13%
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
For present value of cash outflow of 1032.4 , rate is
=
=
12%
+
1045.70 ……….
12%
1032.40
?
1028.1 …………. 13%
x1
12.756
For change in PV of (1045.7 – 1028.1) 17.60
change in rate is 1%.
For change in PV of (1045.70 – 1032.4) 13.3
Change in rate (from 12%) is
12%
27
+
x1
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
Q35
For replacement of existing Bond,
 present value of Net savings in cash outflows in future due to issue of new bond
is to be compared with
 Net cash outflows at the time of replacement (0 period)
 If savings are higher, replacement of existing high coupon rate Bond with new low
coupon rate bond is feasible.
Rs (Million)
Net Cash outflows at the time of replacement ( 0 period)
Callable value of old 12% bond
312
 Tax saving on premium paid on calling old Bond
(12 Million x 0.3)
(3.6)


Tax saving on unamortized floatation cost of
Old 12%bond
(9 Million x 0.3)
(2.7)
Cash Inflows on Issue of New 10% Bond
(300)
+ Floatation Cost of New Bond
Net cash outflow
6
11.7
Present value of Net savings in cash outflows (during the life of new bond) p.a
Interest payable on new 10% bond

30
Tax savings on Interest payable on New 10% Bond
(30 x 0.3)
Tax savings on Installment of Flotation cost of New 10%
Bond to be amortised each year
=
Tax saving

(300 x 0.10)
(9)
I Million p.a
1 million (0.3)
(0.3)
Savings in annual outflow of old 12% Bond
Saving of Interest payable on old bond
(300 x 0.12)
Tax saving on Interest on old bond (36 x 0.3)
Tax saving on Installment of floatation cost of
Old 12% bond
=
36
(10.8)
1.5 Million
Tax saving
1.5 Million (0.3)
(0.45)
(24.75)
Net savings in annual cash outflows
4.05
Present value of Net savings to be accrued in 6 years at 7%
4.05 x 4.767
19.306
Disc rate is cost of deb after tax 10 (10.3) = 7%
By replacing 12% Bond with New 10% Bond Company gains (19.306 – 11.7) 7.606 Millions, So
company should refund the existing Bonds.
28
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
Q36
For replacement of existing Bond,
 present value of Net savings in cash outflows in future due to issue of new bond
is to be compared with
 Net cash outflows at the time of replacement (0 period)
 If savings are higher, replacement of existing high coupon rate Bond with new low
coupon rate bond is feasible.
Rs (lacs)
Net Cash outflows at the time of replacement ( 0 period)
Callable value of old 12.5% bond
315
 Tax saving on premium paid on calling old Bond(15 lacs x 0.5)
(7.5)


Tax saving on unamortized floatation cost of
Old 12.5%bond
Total floatation cost Rs 4,20,000
Written off annually Rs 30,000
Thus life of existing bond 14 years
Unamortised flotation cost 30,000 x 12 = 3,60,000
Tax saving 3,60,000 x 0.5
(1.8)
Cash Inflows on Issue of New 10% Bond
(300)
+ Floatation Cost of New Bond
Net cash outflow
9
14.7
Present value of Net savings in cash outflows (during the life of new bond) p.a
Interest payable on new 10% bond

30
Tax savings on Interest payable on New 10% Bond
(30 x 0.5)
Tax savings on Installment of Flotation cost of New 10%
Bond to be amortised each year
=
Tax saving

(300 x 0.10)
(15)
0.75 lac p.a p.a
0.75 lac (0.5)
(0.375)
Savings in annual outflow of old 12.5% Bond
Saving of Interest payable on old bond
(300 x 0.125)
Tax saving on Interest on old bond (37.5 x 0.5)
Tax saving on Installment of floatation cost of
Old 12% bond
=
37.5
(18.75)
0.3 lac
Tax saving
0.3 lac (0.5)
Net savings in annual cash outflows
Present value of Net savings to be accrued in 6 years
3.975 x 8.384
(0.15)
(18.6)
3.975
33.3264
By replacing 12.5% Bond with New 10% Bond Company gains (33.3264 – 14.7) 18.6264 lac, So
company should refund the existing Bonds.
29
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
Q37
For replacement of existing Bond,
 present value of Net savings in cash outflows in future due to issue of new bond
is to be compared with
 Net cash outflows at the time of replacement (0 period)
 If savings are higher, replacement of existing high coupon rate Bond with new low
coupon rate bond is feasible.
Rs (lacs)
Net Cash outflows at the time of replacement ( 0 period)
Callable value of old 14% bond
342

Tax saving on premium paid on calling old Bond(42 lacs x 0.4)
(16.8)

Tax saving on unamortized floatation cost of Old 14%bond
Total floatation cost Rs 3,0,000
life of existing bond 30 years
Written off annually Rs 12,000
Unamortised flotation cost 12,000 x 25 = 3,00,000
Tax saving 3,00,000 x 0.4
(1.2)

Tax saving unamortised discount
(3)
+
Overlapping Interest on old Bonds 300 lac x 0.14 x
7

Tax saving on overlapping Interest ( 7 x 0.4)
(2.8)

Cash Inflows on Issue of New 12% Bond
(300)
x 25 x 0.4
+ Floatation Cost of New Bond
Net cash outflow
4
29.2
Present value of Net savings in cash outflows (during the life of new bond) p.a
Interest payable on new 10% bond

36
Tax savings on Interest payable on New 10% Bond
(36 x 0.4)
Tax savings on Installment of Flotation cost of New 10%
Bond to be amortised each year
=
Tax saving

(300 x 0.12)
(14.4)
0.16 lac p.a
0.16 lac (0.4)
(0.064)
Savings in annual outflow of old 14% Bond
Saving of Interest payable on old bond
(300 x 0.14)
Tax saving on Interest on old bond (42 x 0.4)
Tax saving on Installment of floatation cost of
Old 14% bond
=
0.12 lac
30
42
(16.8)
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
Tax saving
0.12 lac (0.4)
Tax saving on Installment of Discount of
Old 14% bond
Tax saving
(0.048)
= 0.3 lac
0.3 lac (0.4)
(0.12)
Net savings in annual cash outflows
(25.032)
3.496
Present value of Net savings to be accrued in 25 years
3.496 x 10.675
37.3198
By replacing 14% Bond with New 12% Bond Company gains (37.3198 – 29.2) 8.1198 lac, So
company should refund the existing Bonds.
Q38
Duration of Bond =
Years
1
2
3
4
5
6
Cash outflow
160
160
160
160
160
1160
YTM @ 17%
0.855
0.731
0.624
0.534
0.456
0.390
Duration
=
Volatility of the Bond
Present value
136.8
116.96
99.84
85.44
72.96
452.4
964.40
=
Time
1
2
3
4
5
6
Present value x time
136.80
233.92
299.52
341.76
364.8
2714.4
4091.20
4.24 years
=
=
=
3.624%
For 1% change in YTM, change in price is 3.624%.
If 0.75% change in YTM, then change in Price is 3.624% of 0.75 = 2.71%
If YTM increases, Price of Bond decreases
If .75% increase in YTM then 2.71% decrease in price
New Market price
=
=
962.76 – 2.71% 0f 962.76
936.66
31
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
Q39
Duration of Bond A
Year
1
2
3
4
5
Cash outflow
12
12
12
12
112
YTM @ 15%
0.870
0.756
0.658
0.572
0.497
Duration of Bond =
Volatility of the Bond
Present value
10.44
9.072
7.896
6.864
55.664
89.936
=
Time
1
2
3
4
5
Present Value x Time
10.44
18.144
23.688
27.456
278.32
358.048
3.981 years
=
=
=
3.462%
Time
1
2
3
4
5
6
Present Value x Time
95.70
166.32
217.14
251.68
273.35
3,006.72
4010.91
Duration of Bond B
Year
1
2
3
4
5
6
Cash outflow
110
110
110
110
110
1160
YTM @ 15%
0.870
0.756
0.658
0.572
0.497
0.432
Duration of Bond =
Volatility of the Bond
Present value
95.70
83.16
72.38
62.92
54.67
501.12
869.95
=
4.611 years
=
=
=
32
4.010%
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
Q40
Duration of Bond
Year
1
2
3
4
5
6
Q41a
Cash outflow
x
x
x
x
x
1,00,000 + x
YTM @ 16%
0.862
0.743
0.641
0.552
0.476
0.410
Duration of Bond
=
4.3202
=
Present value Time
0.862x
1
0.743x
2
0.641x
3
0.552x
4
0.476x
5
41,000 + 0.410x 6
41,000 + 3.684x
4.3202 (41,000 + 3.684x)
=
1,77,128.20
+
15.916x =
15.916x – 11.391x
=
4.525x
=
x
=
2,46,000 + 11.391x
2.46,000 + 11.391x
2,46,000 – 1,77,128.20
68,871.8
15,220
Current Market price
41,000 + 3.684x
41,000 + 3.684 (15,220)
97,070
=
=
=
Present Value x Time
0.862x
1.486x
1.923x
2.208x
2.38x
2,46,000 + 2.46x
2,46,000 + 11.319x
` Current yield of the bond is interest earned on Bond on its current market price
Current Yield
=
=
=
15.55%
YTM is the rate of return on bond if it is purchased at current market price and held till the date of
maturity. It is the rate at which present value of cash outflows of the bond is equal to present value
of cash inflows or current market price of the bond.
Approximate YTM
=
=
= 8.421% semiannually
i.e 16.842% p.a
33
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
YTM of bond
Present value of Cash outflow at 8%
=
=
=
=
P.V of interest @ 8% for 10 years
7 x 6.71
46.97
93.27
+
+
+
P.V of redeemable value @ 8%
100 x 0.463
46.3
Present value of cash outflows at 8%
=
=
=
=
P.V of interest @ 9% for 10years
7 x 6.428
44.996
87.196
+
+
+
P.V of redeemable value @ 9%
100 x 0.422
42.2
YTM is the rate at which present value of cash outflow is equal to present value of cash inflows
i.e present value of cash outflow = Rs 90
For Present value of cash outflow of 93.27
For Present value of cash outflow of 87.196
Rate is 8%
Rate is 9%
For present value of cash outflow of 90 , rate is
=
=
=
8%
+
93.27 ………. 8%
90
?
999.80 …………9%
x1
8.538 semiannually
17.076% p.a
For change in PV of (93.27 – 87.196) 6.074
change in rate is 1%.
For change in PV of (93.27  90) 3.27
Change in rate (from 8%) is
8%
34
+
x1
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
b.
Duration of Bond
Year
1
2
3
4
5
6
7
8
9
10
Cash outflow
7
7
7
7
7
7
7
7
7
107
YTM @ 8.538%
0.921
0.849
0.782
0.721
0.664
0.612
0.564
0.519
0.478
0.441
Duration of Bond =
=
c.
Present value
6.447
5.943
5.474
5.047
4.648
4.284
3.948
3.633
3.346
47.187
89.957
=
7.365 / 2 =
7.365 half years
3.6825 years.
Realised yield if intermediate payments cannot be reinvested
= 90
=
(1+r)
=
r
=
=
0.1356
13.56%
35
Time
1
2
3
4
5
6
7
8
9
10
Present Value x Time
6.447
11.886
16.422
20.188
23.24
25.704
27.636
29.064
30.114
471.87
662.571
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
Q42
a.
Since both the bonds are selling at par,it means that expected rate of return or YTM is
equal to coupon rate i.e 8%
Bond with 5 years maturity
Current market price if YTM is 8%
Current market price = P.V of Interest @ 8%
=
80 x
3.9927
=
319.416
=
1000
+
+
+
P.V of redeemable value @ 8%
1000 x 0.6805832
680.5832
Current market Price if YTM is 6%
Current Market price of the Bond is present value of all future cash outflows.
Current market price = P.V of Interest @ 6%
=
80 x 4.212
=
336.96
=
1083.96
+
+
+
P.V of redeemable value @ 6%
1000 x 0.747
747
Thus if YTM decreases to 6%, market price will increase by Rs 83.96
Increase in price due to Interest = 336.96 – 319.416
= Rs 17.544
Increase due to principal
= 747 – 680.5832
= Rs 66.4168
Bond with 20 year maturity
Current market price if YTM is 8%
Current market price = P.V of Interest @ 8%
=
80 x
9.8181
=
785.448
=
1000
+
+
+
P.V of redeemable value @ 8%
1000 x 0.2145482
214.5482
Current market Price if YTM is 6%
Current Market price of the Bond is present value of all future cash outflows.
Current market price = P.V of Interest @ 6%
=
80 x 11.4699
=
917.592
=
1229.39673
+
+
+
P.V of redeemable value @ 6%
1000 x 0.31180473
311.80473
Thus if YTM decreases to 6%, market price will increase by Rs 229.3967
Increase in price due to Interest = 917.592 – 785.448
= Rs 132.144
Increase due to principal
= 311.80473 – 214.5482 = Rs 97.25653
36
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
b.
Duration of Bond
Year
1
2
3
4
5
6
Cash outflow
70
70
70
70
70
1070
YTM @ 7%
0.9346
0.8734
0.8163
0.7629
0.7130
0.6664
Present value
65.4206
61.1407
57.1409
53.4027
49.9090
712.9862
1000
Duration of Bond =
Volatility of the Bond
=
Present Value x Time
65.4206
122.2814
171.4227
213.6108
249.545
4277.9172
5100.1977
5.1002 years
=
=
c.
Time
1
2
3
4
5
6
=
4.7665%
Time
1
2
3
4
5
6
Present Value x Time
63.6364
115.7024
157.776
191.2436
217.3225
3623.9226
4369.6035
Duration of Bond if YTM increases to 10%
Year
1
2
3
4
5
6
Cash outflow
70
70
70
70
70
1070
YTM @ 10%
0.9091
0.8264
0.7513
0.6830
0.6209
0.5645
Duration of Bond =
Present value
63.6364
57.8512
52.5920
47.8109
43.4645
603.9871
869.3422
=
5.0263 years
Due to increase in YTM duration of Bond increases from 5.1002 years to 5.0263 years, so higher
investment is recovered in shorter period of time
d.
Bond Duration is weighted average number of years over which a security’s total cash flows
occur. The weights used are the market value of the cash flows.It is the Average Time taken to
recollect back the investment in Bonds.
Duration of bond is less than Maturity because besides recovery of redemption amount on
maturity, Intermediate cash flows are also received in form of Interest I.e some part of original
investment is recovered every year, so it will take less than Maturity period to recover the original
Investment.
37
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
Q43
Duration of Portfolio is weighted Average of duration of each Bond in the Portfolio, weights being
amount invested in each bond (in terms of face value)
Bond
1
2
3
4
5
6
7
8
Q44
Money Duration
0.10
10.35
0.22
4.25
0.19
7.50
0.07
9.50
0.17
12.67
0.06
5.82
0.11
8.50
0.08
6.71
Duration of portfolio
Weighted Duration
1.035
0.935
1.501
0.665
2.1539
0.3492
0.935
0.5368
8.1109
Duration of Payments
Year
1
2
3
4
Amount
20,000
20,000
20,000
20,000
YTM @ 12%
0.892
0.792
0.711
0.635
Duration
Present Value
17,840
15,840
14,220
12700
60,700
=
time
1
2
3
4
Present value x time
17,840
31,680
42,660
50,800
143180
= 2.359 years
Investment should be made in Bonds in such a way that duration of liabilities matches with
duration of Bond investments. Investment is to be made in zero coupon bond. Duration of Zero
coupon bond is equal to its maturity.
Let investment in 2 year Bond is x
Investment in 5 yr bond is (1x)
Duration of bond portfolio is weighted average of duration of each bond in portfolio, weights being
amount invested in each bond.
x.2 + (1 – x)
2x + 5 – 5x
5 – 3x
x
=
=
=
=
2.359
2.359
2.359
0.880
Thus 88% is to be invested in 2 years bond & 12% is to be invested in 5year Bond.
38
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
Q45
Duration of payments
Year
1
2
3
4
5
Amount
10
9
8
8
7
YTM @ 9%
0.917
0.841
0.772
0.708
0.649
Duration =
=
Present value
9.17
7.569
6.176
5.664
4.549
33.128
Time
1
2
3
4
5
(Rs in million)
Present Value x Time
9.17
15.138
18.528
22.656
22.745
88.237
2.663 years
Liabilities can be immunized by making an investment in zero coupon bonds having
duration of 2.663 years.
Q46a
For Immunisation, duration of bond portfolio should be equal to duration of liability
Duration of Portfolio is weighted Average of duration of each Bond in the Portfolio, weights being
amount invested in each bond (in terms of face value)
Investment in A
Let Investment in B
Let Investment in C
=
=
=
0.50
x
1x
W ADA + W BDB + W CDC = 6
0.50 x 7.35 + x (6.15) + 4.30 x (0.50 – x) = 6
3.675 + 6.15x + 2.15 – 4.30 x = 6
1.85 x = 6 – 2.15 – 3.675
1.85 x = 0.175
X = 0.0945
Weight of B
Weight of C
=
=
=
Investment in A =
Investment in B =
Investment in C =
b.
0.0945
0.50 – 0.0945
0.405
50%
9.45%
40.5%
After the bond portfolio is constructed duration of bonds changed.
Duration of existing portfolio under changed circumstances is
W ADA + W BDB + W CDC
=
0.5 x 7.15 + 0.0945 x 6.03 + 0.405 x 4.27
=
5.87
Duration of Bond portfolio is lower than duration of Liabilities, so liabilities are not
Immunised.
39
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
c.
Proportion of Each Bond to immunize the liability, if duration of each bond in portfolio is
changed
W ADA + W BDB + W CDC = 6
(0.5)(7.15) + (x)(6.03) + (0.5 – x) (4.27) =
6
3.575 + 6.03x + 2.135 – 4.27x
=
6
1.76x =
0.29
x
=
0.164
Weight of B
Weight of C
Weight of A
Weight of B
Weight of c
Q47
=
=
=
=
=
0.164 or 16.4%
0.5 – 0.164
=
50%
16.4%
33.6%
Face value of convertible Bond
Market Price of convertible Bond
Market Price per share
=
=
=
Rs 1,000
Rs 970
Rs 18.50
One convertible Bond
Convertible value of Bond
=
=
50 share
50 x 18.50
i.
=
925
Conversion premium is an additional amount that purchaser of Bond pay over conversion
value
Market price of the Bond – conversion value of the Bond
=
970
925
=
45
% premium on conversion
=
x 100
=
ii.
.336 or 33.6%
x 100
=
4.865%
Premium over investment value = It is the difference between current market price of
convertible Bond and the Investment value of similar Nonconvertible Bond
Investment value of the Bond =
Premium over Investment value =
Rs 870
970  870
% premium over investment value
=
=
=
40
=
x 100
11.494%
100
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
iii.
Conversion Parity price per share = It is the market value of the share based on current
market price of the Bond.
Since Rs 970 (current market price of convertible Bond) is paid for bond which
will be converted into 50 shares, this implies Rs 970 is paid for 50 shares.
Conversion parity price per share
iv.
=
=
Rs 19.4 per share.
Break even period. The yield on a convertible is normally higher than the dividend yield
on the underlying instrument (equity). This circumstance is known as a yield advantage .
The breakeven time/period or payback time/period measures the time it would take for
the yield advantage on the convertible to equal the conversion premium
Yield advantage =
=
=
=
Interest on convertible Bond – dividend on total converted shares
115
2.12 x 50
115 – 106
9
Conversion vaue of share
=
Break even period
=
Rs 45
=
Q48
Coupon rate of convertible Bond is
Rate of similar Nonconvertible Bond
Face value of convertible Bond
Each convertible Bond
Current price of share
=
=
=
=
=
=
8%
10.25% (Discount rate)
Rs 1000
20 shares
Rs 54
a. Straight value of the Bond is Intrinsic value of the Bond =
PV of Interest @ 5.125%
+
=
40 x 12.331
+
1,000 x 0.368
=
493.24 +
368
=
861.24
b. Conversion value of the Bond =
=
=
c.
P.V of Redeemable value
No. of shares per Bond x Market price per share
20 x 54
1080
Conversion Premium =
x 100
=
=
5 years.
x 100
6.481%
41
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
Q49
Stock value of the bond =
=
=
Conversion Premium
conversion value of the Bond
20 x 12
240
=
x 100
=
x 100 = 10.417%
%age of Downside Risk = It is excess of current market price of the Bond over the straight value
of the Bond as a ratio of straight value of the Bond
=
=
x 100
12.766%
Conversion parity price of share =
=
=
Q50
13.25
Straight value of the Bond is Intrinsic value of the bond i.e Present value of all future cash
outflows
Straight value of Bond = P.V of interest @ 7% for 20 years + P.V of redeemable value @ 7%
=
6 x 10.594
+
120 x 0.258
=
63.564
+
30.96
=
94.524
Yield to call
= P.V of Interest @ 7 % for 6 years + P.V of redeemable value@ 7%
=
6 x 0.4.767 + 105 x 0.666
=
28.602 + 69.93
=
98.532
Premium over conversion value =
=
Q51
= 10%
Conversion percentage premium
=
Conversion value of the Bond
=
x 100 = 25.581%
=
430 x 10 = Rs 4300
42
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
Q52
Current market price is present value of all future outflows
Market price of Bond A =
=
=
=
P.V of 9% Interest @ 12 %for 3 years + PV of Redeemable value
90 x 2.402
+
1000 x 0.712
216.18 +
712
928.18
Market price of Bond B = P.V of 10% Interest @ 12%for 5 years + PV of Redeemable value
=
100 x 3.605
+
1000 x 0.567
=
360.5
+
567
=
927.5
Market price of preference share C =
Present value of perpetual 11% dividend @ 13%
= 84.615
Market price of preference share D =
Present value of perpetual 12% dividend @ 13%
= 92.308
Value of Portfolio
Q53
Security
Nos
Bond A
Bond B
Preference share C
Preference Share D
10
10
100
100
Price per
share/ bond
928.18
927.5
84.615
92.308
Total value
9281.8
9275
8461.5
9230.80
36,249.1
Company is considering conversion of 500 Bonds into 10 share per bond.
PE ratio 20 : 1 before conversion
PE ratio 25:1 after conversion
Shares prior to conversion 10,000
Shares after conversion 10,000 + 10 x 500 = 15,000
Statement of Profit
If No conversion
After conversion
EBIT
Interest (5,00,000 x 0.14)
EBT
Tax
EAT
2,00,000
70,000
2,00,000

___________________________
____________________________
1,30,000
45,500
2,00,000
70,000
____________________________
____________________________
84,500
1,30,000
No. of shares
EPS
PE ratio
Market price
10,000
15,000
8.45
8.67
20:1
25:1
20 x 8.45
25 x 8.67
169
216.75
Company should convert the Bonds into shares as after conversion Market price of shares
increases.
43
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
Q54
Current Market price is Present value of all future cash outflows
Market Price
If yield is 12%
= P.V of Interest @ 6% for 6 years + Present value of redeemable value @ 6%
th
for 6 year
=
14 x 4.917
+
100 x 0.705
=
68.838
+
70.5
=
139.338
Market Price
If yield is 15%
= P.V of Interest @ 7.5% for 6 years + Present value of redeemable value @
th
7.5% for 6 year
=
14 x 4.694
+
100 x 0.648
=
65.716
+
64.8
=
130.516
Market price if it is a zero coupon Bond and yield is 14% = Present value of Redeemable value
th
@ 7% for 6 year
=
100 x 0.666
=
66.63
Q55
th
Amount required for making payment on 30 January 2004
Rate of Interest
No. of days to maturity
Amount x (1 + r.
)
=
80,00,000
Amount (1 + .08 .
)=
80,00,000
Amount ( 1.01995)
=
80,00,000
Amount
=
Rs 80,00,000
8% p.a
91 days
=
Rs 78,43,521.74
st
Rs 78,43,521.40 should be invested on 31 Oct. 2003 to make payment of Rs 80 Lakh
th
on 30 jan 2004
Q56
Amount required for making payment in 60days
Rate of interest
No. of days to maturity
Amount x (1 + r.
)
Rs 20,00,000
8% p.a
60 days
=
20,00,000
Amount (1 + .08 .
)=
20,00,000
Amount ( 1.01315)
=
20,00,000
Amount
=
=
Rs 19,74,041
Rs 19,74,041 should be invested on to make payment of Rs 20 Lakh in 60 days
44
PRAVINN MAHAJAN CLASSES 9871255244, 8800684854
Q57
Assume that the company has issued Commercial paper worth Rs 10 crores
No. of Days
=
90 days
Interest rate
=
11.25%
Amount x (1 + r.
)
= 10 crores
)
Amount (1 +0 .1125 .
Amount (1.028)
= 10 crores
= 10 crores
Amount
=
Amount received by the company on issue of commercial paper Rs 9.728 crores.
Q58
Issued at
Redeemed at face value
Interest
97,350
1,00,000
2,650
Effective rate of Interest =
x 12 = 10.89%
Statement of cost of funds to company
Effective rate of Interest
Brokerage (0.125 x 4)
Rating charge
Stamp Duty (0.125 x 4)
10.89 %
0.50%
0.50%
0.50%
12.39%
45