ByHemendra Shaktawat MBA III

In general, the value of an asset is the price that a willing and able buyer pays to a willing and able seller. Note that if either the buyer or seller is not both willing and able, then an offer does not establish the value of the asset.

There are several types of value, of which we are concerned with three:

Book Value - The assets historical cost less its accumulated depreciation. Market Value - The price of an asset as determined in a competitive marketplace. Intrinsic Value - The present value of the expected future cash flows discounted at the decision makers required rate of return.

There are two primary determinants of the intrinsic value of an asset to an individual:

The size and timing of the expected future cash flows. The individuals required rate of return (this is determined by a number of other factors such as risk/return preferences, returns on competing investments, expected inflation, etc.)

A bond is a tradeable instrument that represents a debt owed to the owner by the issuer. Most commonly, bonds pay interest periodically (usually semiannually) and then return the principal at maturity. Most corporate, and some government, bonds are callable. That means that at the companys option, it may force the bondholders to sell them back to the company. Ordinarily, there are restrictions on the timing of the call and the amount that must be paid.

There are two types of cash flows that are provided by a bond investments:

Periodic interest payments (usually every six months, but any frequency is possible).

Repayment of the face value (also called the principal amount) at maturity.

The following timeline illustrates a typical bonds cash flows: 1,000

100 0 1 100 2 100 3 100 4 100 5

We can use the principle of time value of money to find the value of this stream of cash flows. Note that the interest payments are an annuity, and that the face value is a lump sum. Therefore, the value of the bond is simply the present value of the annuity-type cash flow and the lump sum:

V= C(PVIFA)r,n + MV(PVIF)r,n

Coupon Rate - This is the stated rate of interest on the bond. It is fixed for the life of the bond. Also, this rate determines the annual interest payment amount.

Face Value - This is the principal amount (nominally, the amount that was borrowed). This is the amount that will be repaid at maturity. Maturity Date - This is the date after which the bond no longer exists. It is also the date on which the loan is repaid and the last interest payment is made.

Assume that you are interested in purchasing a bond with 5 years to maturity and a 10% coupon rate. If your required return is 12%, what is the highest price that you would be willing to pay?
100 0 1 100 2 100 3 100 4 1,000 100 5

year time period 10% coupon rate. Maturity value- 1000 Rate of return-12% Coupon rate= 1000*10/100= 100 Formula V= C(PVIFA)r,n+ MV(PVIF)r,n V= 100(PVIFA)12,5 + 1000(PVIF)12,5
V= 100(3.605) + 1000(0.567) V= 360.5 + 567 V= 927.5 { PVIF= 0.567, PVIFA= 3.605 This value referred from table .}

The value of a bond depends on several factors such as time to maturity, coupon rate, and required return. We can note several facts about the relationship between bond prices and these variables.

Higher prices, Higher prices, Longer prices,

required returns lead to lower bond and vice-versa. coupon rates lead to higher bond and vice versa. terms to maturity lead to lower bond and vice-versa.